Dollar-Cost Averaging vs. Lump-Sum Investing
Understanding when to invest and how to invest is always a challenge. With cryptocurrencies that can experience huge daily (if not hourly) price variations, meme stocks rising unexpectedly from the grave, markets crashing regularly due to political uncertainties and a global pandemic, figuring out an investing plan has become harder than ever. But we decided to rescue you and take some time to present two simple investment strategies with different pros and cons that can help you move your first steps into the investing world. After reading this post, stocks and crypto won't look so scary anymore.
Lump-Sum Investing
Let's start by saying this: it doesn't matter how hard you try, it's not possible to make predictions about the future. Or at least, not 100% accurate ones. But some trends have proved true for a long time in the past. One is that markets, over long periods of time, tend to grow.
The definition of lump sum can vary according to the person. You might have inherited some money or received a big bonus at work. Lump-sum investment means that you're grabbing your chunk of money and investing it in one go. No second thoughts, no scares of a market crash; you choose your stock (or stocks or ETFs or any other assets) and simply go for it. Quite risky, isn't it? Well, the key point here is that you're aiming to benefit from markets rising long-term. You might be investing in stocks, shares, pension funds or crypto, or spread your money over different assets, but essentially, your money has been invested in one go, and you're sitting down and watching how it performs.
What are the advantages of this strategy? As it's widely accepted that investing in the long term is the most rewarding method, several different statistics show that investing a lump sum and leaving it to deal with the various peaks and troughs of the market will net a greater return.
By putting all your money in, you can get it to work for you faster and start compounding and collecting dividends. The tricky part is choosing where to invest. And that's where the downside is. As you're putting all your money at risk at once, it's essential to choose your portfolio wisely. Diversifying is important here.
Not everyone has the same passion for risks or a significant amount of money available immediately. That’s where this next method comes in.
Dollar-Cost Averaging
In the beginning, we said that some trends in the markets are easy to spot, remember? This awareness is not enough for people who choose Dollar-Cost Averaging (DCA).
DCA is a long-term investment strategy where an investor buys smaller amounts of one or more assets over time without giving too much importance to the actual price. For example, you can decide to invest €200 per month for a year instead of €2,400 all at once. Your DCA schedule can vary over time, depending on your goals, and it can last for some months, up to several years.
Same as lump sum investing, there are some pros and cons about this. It can be a valuable strategy for newbies because it helps to mitigate the volatility. The goal of DCA is to average any dramatic increase or decrease in your portfolio and benefit a little bit from price variations in any direction. In case of a market crash, you won't have to deal with a feeling of despair thinking about all your savings evaporating from one day to another (hey, bitcoin, can you hear me?). If markets go up, you will still benefit from the upcoming trend by sticking to your DCA plan. It's also entirely based on avoiding emotional trading – aka overbetting due to FOMO/panic selling during a downturn – as the key point here is always to stick to the plan.
The downside of this strategy is that financial gains are slower and more modest, as you're making an incremental investment over time.
How do these two strategies work in practice?
I love cryptocurrencies, and they're super volatile, so something like Bitcoin is perfect for showing the difference between the two strategies. Let's dig into some examples by using real-world prices.
Let's first look at our DCA strategy. If you decided to invest $50 in bitcoin every week, starting from July 1, 2017, you would have invested a total of $10,450. On July 1, 2021, despite several market crashes in the last months, your portfolio would be approximately worth $44,661.
Now let's do the same calculation, but let's pretend you had $10,450 immediately available (your last job payout + all those Christmases putting money in the piggy bank are finally paying off) and decided to invest it all at the same time. On July 1, 2021, your bitcoin portfolio would be approximately worth $145,380.
Looking at these two calculations, it's pretty evident that the "all-in" investment is the one that would have earned you the higher profit. But think about all the crashes bitcoin had in the last years; not everyone would have resisted this kind of pressure and avoided selling everything after a nervous breakdown. It’s possible you would have sold out your position at the wrong moment and been left with much less than you started with.
What matters is that both strategies can make your money grow in the long term. You have to find the right balance between your existing capital, your plans for the future, your willingness not to touch the investment you're doing and the diversification of your portfolio. Some people appreciate the adrenaline they have while walking on a tightrope. Others prefer a stable plan for the upcoming years. The choice is, as always, up to you.
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