Should I Invest a Lump Sum at Once or Through Dollar-Cost Averaging?

Most of us have dreamed about suddenly receiving a large pile of money.

But, if you’re financially responsible, you may be wondering whether to invest all at once or to dollar-cost average. Which one is the better financial decision?

That’s what a listener of the Clark Howard Podcast recently asked.

Investing: Lump Sum vs. Dollar-Cost Averaging

What should you do with a lump sum, inheritance or windfall?

That’s what a listener wondered on the Dec. 16 podcast episode.

Paul in Michigan said: “I’m very fortunate to be receiving a large lump-sum pension. I’m confident in the stock market and plan to invest most of it in a variety of stock market index funds within my 401(k) … I read, see and hear conflicting advice on whether to invest it all at once or dollar-cost average. What is your advice?”

The answer to this question depends on your personality and how comfortable you feel with risk.

“I love dollar-cost averaging because of the psychological harm if you put in a lump sum and all of the sudden the market has a big decline,” Clark says. “The math, though, over the decades finds that on average you end up with more money putting in lump sums than putting in equal amounts month after month.”

If the historical math favors investing a lump sum as soon as possible, the state of the market at the time of Paul’s question may have tilted the odds even further. At the time, the S&P 500 had declined 18.8% for the year.

As of July 13, 2023, the S&P 500 had gone up 17.5%. So by putting the money into the market in a lump sum, Paul may have capitalized on the strength of the market in the first half of this year.

While there’s no guarantee that the market is going to be in the green after a recent downturn, the stock valuation of the average American company is more reasonable compared to earnings and profits than it has been in years.

But inflation is creeping closer to historical norms and the Fed probably is close to halting interest rate hikes. Historically, when the market gives up gains, it doesn’t take too many years for it to get back to even and then claw toward the green again.

Investor Psychology: A Second Look

Keep in mind that if you’re investing for the long term, even if you invest a lump sum and see an immediate decline, you’ll have time for it to grow. Plus, you may feel bad if you decide to wait and the market spikes.

“The psychological, though, is very important. Because people can feel devastated if they worked hard through a working lifetime, get that lump sum and then bam, it gets blown away in short order,” Clark says.

“So if you would lose sleep, you would be twisted in knots if there was a big decline right after you put in a lump sum, go with dollar-cost averaging as a way of peace of mind, putting this money aside for your future.”

Clark’s 90/10 Rule

Paul sounds like a practical person.

But for the average person, deciding to dollar-cost average can also lead to poor decisions. The longer you’re holding that money in your bank account, the more likely you are to use it on something you don’t need. And if you’re skimming off a little here and a little there, over time, you may not realize how much you’ve spent.

However, if you come upon a lump sum of money, Clark doesn’t think you should invest every single dollar. He wants you to take 10% and spend it however you want.

Use the 10% to go on the vacation of a lifetime, buy the newest Corvette or invest in your friend’s dog toy startup if that’s what you want to do.

Clark compares this to going on a diet. If you never have a “cheat day” or some way to reward yourself occasionally, you’ll probably backslide eventually — sometimes with disastrous consequences.

Final Thoughts

Deciding between investing a lump sum in one aggressive splash or dollar-cost averaging is a personal choice. The math says to put it all in as soon as you can.

But if that’s going to make you lose sleep — especially if the market declines after you’ve invested — maybe you should consider dollar-cost averaging.

If you’ve received a lump sum all at once, also consider Clark’s 90/10 rule and spend 10% of it on anything you want.