Should you invest all your money at once?

I help expats get started with investing and one of the most common question I get is:

"Do I invest all my money now or do I spread it over time?

Let me introduce to the DCA technique.

DCA (or Dollar-Cost Averaging) is a wonderful little technique to increase investment returns while minimizing risk. It’s super useful for new and advanced investors alike.

What is DCA?

DCA can be summed up in one sentence: Invest the same amount of money each time period, regardless of the price.

It's simply about spreading out your investment over a period of time. Here’s an example:

Let’s say you’ve been saving money for a while and are looking to invest it in the stock market. You’ve got two choices:

???(i) Invest everything at the same time or;

???(ii) Spread out your investment over several months or years.

Option 1 is risky. You risk investing all of your money at the wrong time (e.g. during a stock market bubble). While bubbles are rare, they do happen.

Option 2 is safer. Spreading out your investment allows to keep buying into the stock market month after month, thus minimizing the risk of buying in the market at the wrong time.

How does DCA work?

Spreading out your investment is easy. Here’s an example:

Let’s say you’ve got $10,000 to invest, you could choose to invest $1,000 each month for 10 months for example.

This means you’ll be investing the same amount of money every month regardless of whether the market went up or down. That's all there is to it.

Did you know?

The amount invested every month and the time period chosen (weekly / monthly / quarterly) does not matter. What is important is to keep investing steadily.

Why does DCA work well?

Remember the old trader motto “Buy low, sell high“?

Well DCA allows you to something along the same lines: Buy low, buy less (when its) high.

Here’s how it works:

By investing a fixed amount (e.g. 1,000$) in the stock market each week/month/quarter, you will be buying at all times of the business cycle. This means, you’ll occasionally buy when the market is high and when it’s down.

In other words, your 1,000$ will have a different purchasing power every month. When the market is down, your 1,000$ will be worth more shares and, when the market is up, your 1000$ will be worth less shares.

In practice, this means that you will buying more shares when the price is low, thus ensuring better returns over the long term!

You'll be literally buying low and buying less high.

TIP - DCA works best with index funds

For optimal performance, aim to practice DCA with index funds (e.g. an ETF tracking the US stock market). DCA with individual stocks doesn't work as well, it gets mixed results due to the volatile nature of certain stocks.

What are the downsides of DCA?

DCA only works well in the short term, think up to a year (or two if the lump-sum is really large).

Spreading out your investment over a longer period (e.g. 20 years) is likely to be disappointing as you’ll be out of the market for a long time and inflation will eat away at your cash savings.

The stock market has a tendency to go up over time. This means that, the longer you spread out your investment, the more the stock market goes up and thus the lower your expected returns.

Additionally, DCA requires discipline on your part. You must ensure that you invest the same amount every month to do it correctly. This means you can’t get greedy because your favorite politician just got elected, and you can’t chicken-out when the stock market crashes. DCA only works if you see it through.

To sum up

Dollar Cost Averaging (DCA) is about investing the same amount of money at each time period, irrespective of market conditions. DCA is a great and easy way to reduce your risk and increase performance over the short term.

However, DCA only works in the short term. Spreading out your investment over decades will only lead to lower performance as you’ll be keeping your assets in cash instead of in the market. Remember: Time in the market is better than timing the market!

Verdict: Great for getting started while reducing risk, as you shouldn't be keeping large amounts of cash idle anyway!

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