Dollar-Cost Averaging: Is it Better to Dive in or Dip Your Toes?

Dollar‑cost averaging is a popular investment strategy that involves systematically investing a fixed amount of money in the market at regular intervals over time. Alternatively, with lump sum or

immediate investing, the investor dives in headfirst, placing their entire amount in the market all at once. Statistics show that investing all at once often outperforms dollar-cost averaging. So, why do so many investors still stick with it?

Why Stick with the Plan?

We believe there are several reasons. First, dollar‑cost averaging helps investors avoid the risk of putting all their money in the market at an inopportune time, such as just before a major market correction. Such unfortunate timing might deter investors from future investments. In contrast, investing at a slower pace may alleviate the anxiety and remorse many investors feel after a steep market decline. What’s more, investors who start dollar‑cost averaging just before a bear market hits can benefit by purchasing more shares at lower prices, effectively turning market downturns to their advantage. In this way, dollar‑cost averaging not only reduces the risk of investing but also acts as a safety net against volatile markets. Finally, dollar‑cost averaging may be ideal for those who might otherwise be paralyzed by fear, ultimately helping them take the plunge.

Ultimately, all of these reasons act as psychological insurance, making the act of investing easier and reducing the risk of regret or fear of entering the market. If that helps investors get invested and have their assets in the market longer, it’s a net benefit.

These insights on dollar‑cost averaging are well known. After all, dollar-cost averaging has been extensively studied, including in Bernstein’s 2008 white paper “Entering the Market,” which analyzed its trade-offs using historical S&P 500 data. Since then, diverse market conditions—such as the 2008 financial crisis, the 2020 COVID downturn, inflation spikes, and recent interest rate hikes—raise the question: do the paper’s conclusions still apply now. 

Revisiting Dollar‑Cost Averaging with New Data

To answer this question, we have updated our prior research with 16 years of new data. In doing so, we confirm that the following conclusions still hold:

1. In typical markets, the approach reduces investors’ returns compared to investing immediately. This pattern persists regardless of whether the market was rising or falling in the year leading up to the investment’s inception, and it holds true whether investments are made during market dips or upswings.

 

2. Dollar‑cost averaging helps preserve capital during declining markets. If the market performs poorly while averaging in, this strategy results in more wealth than investing all at once. So, while reducing median returns in most scenarios, dollar‑cost averaging also narrows the range of returns.

 

3. When going this route, the optimal balance between cost and benefit occurs over a period of no more than six months. Beyond that, the cost starts to outweigh the benefit, and after 18 months, the cost of missing substantial gains far outweighs the potential benefits.

 

Exploring the Trade‑Offs from New Angles

Our full white paper dives deeper into these takeaways while exploring several new insights:

• The effectiveness of dollar‑cost averaging is notably influenced by market valuation at the outset of the investment period. In particular, the excess CAPE yield emerges as a useful indicator for determining when dollar‑cost averaging may offer a better cost-benefit trade‑off compared to investing immediately.
• The trade‑off between costs and benefits is more advantageous in US small-caps and emerging markets compared to US large-caps, making dollar‑cost averaging more likely to outperform in these asset classes. Conversely, when it comes to bonds, the trade‑off is less favorable than it is for US large-caps.
• When taxes enter the equation, both the cost and benefit of dollar‑cost averaging versus investing immediately are dampened, particularly when factoring in tax-loss harvesting considerations.

 

Ultimately, whether investors choose to invest immediately or to dollar‑cost average in, it is essential to set a clear time horizon, establish a long-term strategic asset allocation, and stick to the plan. Trying to time the market or allowing emotions to dictate investment decisions can significantly undermine long-term wealth accumulation.