Lump-Sum Investing vs Dollar Cost Averaging

Both lump sum investing and dollar cost averaging are popular ways of investing into the market. Both of these methods can provide you with some benefits and a few drawbacks. Here are the basics of lump sum investing and dollar cost averaging and how they compare to one another.

Lump-Sum Investing

Lump-sum investing involves taking all of the money that you are going to invest and putting it into the market at once. For example, let's say that you had $10,000 to invest. With lump sum investing, you are going to take the entire $10,000 and put it into a stock, mutual fund, or some other type of investment. 

Dollar Cost Averaging

Dollar cost averaging is a long-term investment approach that utilizes small, regular investments. With this type of investment, you are going to spread out your investments over a long period of time. For example, let's say that you still had $10,000 to invest. Instead of putting it all into the market right away, you are going to spread it out over several payments. You might decide to invest $1000 per month for the next 10 months. 

Advantages of Lu mp-Sum Investing

Using the lump-sum investment strategy can provide you with some benefits. As far as pure profit potential, this is going to be the superior option. If you choose the right security to put your money into, you could potentially make a large return on your investment. For example, let's say that you had $10,000 and you put it all into a particular stock. The price per share is $2 when you buy. Then, the next month, the price of the stock increases to $6 per share. You have just tripled your investment and you now have $30,000. If you had used dollar cost averaging, you would have invested $1000 the first month. The value of that $1000 would have tripled to $3000. When you add that to your remaining $9000, you have $12,000. By putting the entire amount of your investment into the market, you made $18,000 more than if you would have used dollar cost averaging.

Advantages of Dollar Cost Averaging

Even though lump-sum investing has the highest potential, dollar cost averaging has some value too. One of the biggest advantages of dollar cost averaging is the psychological benefits that you get. Many people are scared to invest a large sum of money into a security or group of securities. There are many things that can happen in the market and your investment could potentially plummet shortly after you get involved. With the same example as above, let's say that you invested $10,000 into a stock that was selling for $2 per share. After one month, the price drops down to $1. You have lost $5000. If you had used the dollar cost averaging approach, you would have invested $1000. Your investment would then be worth $500. Overall, you would only be down to $9500 instead of $5000. 

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