Research Indicates Lump Sum Investing Often Beats Dollar Cost Averaging

Dollar cost averaging (DCA) is still promoted by both the popular press and the professional money management establishment as a better investment strategy than lump sum investing. I don't intend to argue against DCA here, but I do want to point out some credible academic research indicating that DCA is not as successful as claimed relative to some other strategies, specifically the lump sum approach.

Below are two excerpts from a research article by Richard E. Williams, Ph.D., and Peter W. Bacon, DBA, CFP, "Lump Sum Beats Dollar-Cost Averaging," first published in the The Journal of Financial Planning, April, 1993. The first paragraph is the summary section in its entirety. The second paragraph contains excerpts from the Conclusion.

This article compares the annualized returns from various dollar-cost averaging strategies with those produced by lump-sum investing from 1926 to 1991. For all time periods and averaging strategies investigated, lump-sum investing produced superior returns to dollar-cost averaging, and in all but one instance, the differences were significant at the .005 level. Based on these results, financial planners should advise clients wishing to make sizable cash investments in the market to invest as soon as possible. Dollar-cost averaging is unlikely to produce superior results to lump-sum investing.

... The DCA approach has received wide acceptance in the literature when the assumption is that equal dollar amounts, taken from current income, are invested periodically in stocks, thus avoiding the possibility of investing all the money at a market high. Our study looks at the problem from a different perspective. Given a lump sum, is it better to invest the entire amount immediately, or spread it out in equal installments? Based on historical evidence, the major conclusion of our study is that the odds strongly favor investing the lump sum immediately. This conclusion emerges after comparing annualized monthly returns for both DCA and LS strategies for all possible 12-month periods from 1926 to 1991. For the entire 65-year period, the LS strategy produced superior returns approximately two-thirds of the time, and the superior returns were statistically significant. How do we account for these results? The primary explanation seems to center on the positive risk premium that exists in the great majority of time periods. Thus, there is normally a relatively high opportunity cost associated with holding the uninvested portion of an endowment in a risk-free asset. Approximately one-third of the time, however, DCA did produce superior results to LS investing. The authors are currently examining those time periods for common causal factors. There is, of course, no assurance that the past pattern of stock market and T-bill returns will persist in the future....

This article suggests that if an investor has a lump sum, it might be better to invest it all at once. Note the caveat here: "Approximately one-third of the time, however, DCA did produce superior results to LS investing." Let's wait until "The authors [have examined] those time periods for common causal factors." The lump-sum strategy would be appropriate for IRA and 401(k) rollovers, a lump sum inheritance, and the like. But the fact is, most investors don't have large lump sums to invest, but they do add money to their portfolios in a periodic fashion over long periods. So using DCA or a similar strategy like value averaging might provide better returns than not using them if the lump sum strategy is off the table or is otherwise inappropriate.

Other Sources:

• The full text of the article quoted above, "Lump Sum Beats Dollar-Cost Averaging," can be found in its reprinted form celebrating the 25th anniversary of the Journal of Financial Planning.
• The first, and now classic, research to question the superiority and effectiveness of DCA was from George M. Constantinides in his "A Note on the Suboptimality of Dollar-Cost Averaging as an Investment Policy," in the Journal of Financial and Quantitative Analysis, XIV, June 1979, pp. 443-50.
• For an alternative to both lump-sum and DCA strategies see "The Value Averaging Advantage " at justforfunds.blogspot.com.