If you suddenly find yourself with a big chunk of change - say from a lump-sum pension payout or an inheritance - it can be tough deciding whether to invest it all at once or gradually through "dollar-cost-averaging."
Although dollar-cost-averaging (investing a fixed dollar amount each month) is a practical strategy in many instances, two new studies conclude that you're better off investing a lump sum all at once.Richard Williams and Peter Bacon at Wright State University, in Dayton, Ohio, say your best bet is to pour rather than spoon the money into selected investments. That's what they concluded after studying the two approaches for a client with a big inheritance.
Williams and Bacon compared the total return on $120,000 invested at the start of the year in the stocks that make up Standard and Poor's 500-stock index with a gradual, dollar-cost-averaging approach. With the second approach, the money was held in 90-day Treasuries and invested in $10,000 increments over 12 months. The result: Over one-year holding periods from 1926 through 1991, the lump-sum strategy significantly outperformed dollar-cost-averaging about two-thirds of the time.
A more recent study confirms Williams' and Bacon's findings, except in the fixed-income arena rather than stocks. The study, "Does Dollar-cost Averaging Work for Bonds?", which used long-term Treasuries and corporate bonds in place of the S&P 500, found that lump-sum investing again topped dollar-cost-averaging about two-thirds of the time.
But these studies are a world away from the fears and anxieties ordinary retirees must contend with when investing their money. Dol-lar-cost-averaging reduces the risk of loss if an investor encounters a prolonged stock-market slump, and it helps sidestep a feeling of regret later on. Financial planners use it for all those reasons and because it can give investors the courage they need to put the desired amount of money into stocks.
If you decide to use dollar-cost averaging, don't drag the process out too long. Many planners recommend a 12-month payout plan at the most - less with modest sums.
For copies of the studies, send a $5 check (or $3.50 for one study) and a self-addressed, stamped, business-size envelope to the Institute of Certified Financial Planners, 3801 E. Florida Ave., Suite 708, Denver, CO 80210-2571.