Thursday, January 29, 1998

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (Jan. 29, 1998) -- We often get readers who come to us for the first time after having received a large sum of money all at once, either through an employee retirement plan roll-over, a gift, an inheritance, or perhaps an insurance settlement. Inevitably they want to know whether they should invest the lump sum all at once or whether they should invest portions of it slowly over a year or so until it's all in the market.

I've heard endless legions of the Wise tell investors to "dollar-cost average" the lump sum over a year or two to protect it against a market drop. But I couldn't disagree more. And it appears I'm not alone in this belief.

First, dollar-cost averaging is no guarantee against losses. What's to say that the market plunge you're hoping to protect against won't just wait until after you're done dripping the money into the market, if indeed it comes at all? It's quite possible still to suffer the major loss and pay higher commissions in the process. At best, dollar-cost averaging the lump sum protects you for the one year during which you're slowly adding the money, but is that protection worth it?

Not if you look at historical performance. A 1993 study in the AAII Journal (June issue) studied the question from 1926 to 1991. The authors found that lump sum investing was significantly better than dollar-cost averaging two thirds of the time. What the dollar-cost averaging advocates are ignoring is the opportunity cost of being invested during that full year and the fact that the market goes up far more often than it slumps.

Another study, published in the May 1997 issue of Bank Investment Marketing, studied the period from 1950 to 1993. In the 40 five-year periods between those dates, dollar-cost averaging only performed better than lump sum investing on one occasion. That's right, one for forty!

If you're a long-term investor and this money is going to remain in the market once its invested, there's no mathematical support for the idea that investing the money slowly over time is a good choice. Sure, you could be the one out of forty who loses by the practice, but those are odds most investors would love to have on their side.

Now don't confuse this with the practice of true dollar-cost averaging, which is the method of adding new money you save regularly to your portfolio. When stocks are down, you buy more shares. When stocks are high, you buy fewer, thus lowering your average price per share. We love the idea of Fools adding money regularly to their portfolios. It's the surest way to build long-term wealth. In fact, tonight's Foolish Four column deals with one such method for using the practice. Fool on!

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