Welcome to your “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.
Today’s question is about investing methods; specifically, when approaching the stock market, is it better to invest systematically monthly, or just to put everything in at once in a lump sum?
Investing a fixed amount monthly — known as dollar-cost averaging, or systematic investing — seems like it would make the most sense. But when you do the math, it may not be the way to go. To learn why, check out the following video. Or, if you prefer, scroll down to read the full transcript and find out what I said.
You also can learn how to send in a question of your own below.
For more information on this topic, check out “The Best Asset for Long-Haul Investing? It’s Probably Not What You Think” and “How to Get Started Investing When You Don’t Have Much Money.” You can also go to the search at the top of this page, put in the word “investing” and find plenty of information on just about everything relating to this topic.
Got a question of your own to ask? Scroll down past the transcript.
Don’t want to watch? Here’s what I said in the video
Hello, everyone, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this question is brought to you by MoneyTalksNews.com, serving up the best in personal finance news and advice since 1991.
Let’s go to our question today. It’s from Richard:
“Let’s say I’ve got an extra 200 bucks a month after all my bills are paid. Should I take that $200 and invest it monthly, which is dollar-cost averaging? Or, should I save it, and then at the end of the year, invest $2,400?”
Let’s talk about dollar-cost averaging versus lump sum. Dollar-cost averaging is a tried-and-true method of investing, and it’s one I recommend.
When you just look at the math, lump-sum investing will outperform dollar-cost averaging. Why? Because the stock market typically rises; positive years far outweigh negative years. Since that’s true, the sooner you invest, the better off you’ll be. Of course, this isn’t always true, but the odds favor putting money to work ASAP.
There are calculators online that prove this. You can find one at Moneychimp, for example.
However, Richard’s choices were to invest $200 a month now or wait until the end of the year to invest $2,400. So, in this case, we’d want to invest the $200 a month now to get the money to work sooner.
Even though dollar-cost averaging may not be the mathematically correct answer, that doesn’t make it the wrong answer. In my experience, when I plop down a bunch of money all at once in the stock market, it’s about to go down — just like it’s going to rain if I just washed my car. And if I invest a lump sum and the market drops the next day, I’m not a happy camper. I’m gonna think, “Oh no! I shouldn’t have invested it all at once!”
In short, the math may indicate that lump-sum investing outperforms, but your temperament and peace of mind also come into play. I feel that if I put in a little bit every month, I’ll be more comfortable. If the stock market drops, my next investment will buy more. When the stock market’s high, I’m buying fewer shares. Over long periods of time, this is going to reward me.
As far as I’m concerned, I’m less stressed when I’m putting in a little every month, and I could perform practically as well over the long term anyway. So, why not dollar-cost average?
I hope that answers your question, Richard. Have a profitable day and meet me right here next time!
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I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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