(Aaron Vincent Elkaim/Canadian Press)
In just a few months, some of us will be receiving our year-end bonuses. And if you’re planning on saving that windfall, you’ll be faced with a tough decision: sock it all away at once or invest a little of it every month?
Most financial institutions recommend the latter. Dollar-cost averaging—buying the same value of stocks at regular intervals—is touted as a way to avoid market timing and reduce investment risk. It also forces you to buy more shares when prices are low and fewer when prices are high.
But lately, some dissenting voices have challenged this market mantra. In a paper released in October, Raffaele Zenti, co-founder of Italian financial education firm Advise Only, found that lump-sum investing outperforms dollar-cost averaging most of the time. What most dollar-cost averaging advocates fail to factor in is the brokerage fees paid each time to buy the shares, which Zenti calculates will eat up 8% of your return over an extended period. (Mutual fund investors would not incur that added cost.)
Zenti looked at how three different dollar amounts on three different exchanges would perform over five, 10 and 20 years. The gap was less pronounced during shorter time periods, but grew the longer the cash was invested. For instance, a $120 lump sum invested in the S&P 500 for 10 years had a 20% higher return than when invested in monthly increments.
The Vanguard Group studied this too, with similar results. It compared the returns on $1 million invested over rolling 10-year periods going back to 1926. The lump sum was invested immediately, while cash was deposited every month for a year in the DCA scenario. Two-thirds of the time lump-sum investing outperformed. Daniel Wallick, a principal at Vanguard, explains that the research isn’t saying to hang onto your money and invest it later. Rather, invest what you have as soon as you can. A bonus should be deposited immediately, but it’s better to invest some money off each paycheque than to accumulate it in a savings account in order to invest a larger sum in the future.
One reason to spread your bonus out over a longer period of time remains: fear of negative returns. If you invest it all and the market falls, you’ll lose a lot more than if you took the DCA approach. But if you can stomach some uncertainty, then take that bonus straight to your broker.
