Should You Invest a Lump Sum or Dollar-Cost Average Into ETFs?
Key Points
Spreading out your entries into new positions in stocks reduces your risk of inflated entry prices.
Investors’ biggest risk is missing out on the market’s best days, even if that means suffering its worst days.
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It's an age-old question. Should you invest a sizable stash of cash all at once, or space your investments over time (an approach called dollar-cost averaging)? The former risks putting all of your money in at a market high. The latter risks missing out on any upside that takes shape before you've put all of your money to work.
There is a correct answer, particularly if you're a true long-term investor. That is, invest as much money as you can as soon as you can. See, perhaps the biggest risk all investors face is missing out on the few truly great days the broad market experiences in any given year.
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And that's no small risk.
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Number-crunching done by mutual fund company Hartford puts things in perspective, indicating that since 1996, a $10,000 investment in the S&P 500 or funds like the SPDR S&P 500 ETF Trust and the Vanguard S&P 500 ETF meant to mirror it would be worth over $192,000 today (assuming reinvestment of its dividends). If you missed out on just the market's 10 biggest daily gains during this stretch, however, that $10,000 investment would only be worth a little more than $85,000. That's less than half of what you'd have by simply staying put.
The point is, the biggest long-term risk investors face isn't being in the market at the wrong time, but not being in the market at the right time. That's true even if you're adding capital to your portfolio over time.
Don't count on only being on the sidelines during the bad times and in the market during the good ones either. Hartford adds that over 40% of the S&P 500's best days since 2005 materialized during a bear market. Sure, it's miserable while you're taking your lumps. As Hartford's research explains, though, most bear markets last less than a year. One-third of the market's best days also take shape in just the first two months of new bull markets.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
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