Personal Finance Guide

Dollar Cost Averaging is a great way to invest money from a paycheck or other regular income. But what if you have just received a lump sum from a pension payout or an inheritance from a relative? Should you put all of your money into mutual funds all at once or move money into mutual funds gradually as in Dollar Cost Averaging?

There have been many studies to determine if it is better to invest all the money as soon as possible or to gradually invest little by little. Research has shown that about two thirds of the time, putting money into the stock market all at once beats Dollar Cost Averaging. Since stocks rise more than it falls and stocks usually perform better than money market funds, it is not surprising that investing money in the stock market all at once yields better investment returns.

since overall, investing in stocks yields better returns than just putting money on the side in a money market fund, if you have the money to invest, leaving it out of the stock market will just drag down your overall return.

In many cases, however, investors want to invest in according to their Risk Tolerance and time horizon. For example, investors are not only concerned which of the two methods (investing all now or dollar cost average) will yield the best overall results but will yield the best in, say 2 years time when they need to buy a house using some of the investment money. When investors are concerned about which investment method is best under certain circumstances, a different approach of investment is needed. If the investor need to withdraw money in two years, perhaps the investor should not use that money to invest in the stock market at all.

Simply put, once you have determined your Asset Allocation mix, say 60% stocks, 30% bonds, and 10% cash, you can use the same Asset Allocation mix for the lump sum investment. In this example, you will divide the lump sum into 60% stocks, 30% bonds and 10% cash as well.

However, there is an exception to this simple rule. If your Asset Allocation is for a small amount of money and you inherit a large sum of money. Then, you may want to determine a new Asset Allocation – one that you are comfortable with. Your Risk Tolerance may have change based on the new amount of investment money you have. For example, you may want to be very aggressive with the $5,000 you currently have but when you inherit $1,000,000, you may want to be more conservative. In which case, Dollar Cost Averaging may be a way you want to gradually invest in the stock market.

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