By Francis Bayes, WCI Columnist
When my wife and I married and merged our finances, we transferred the cash in her savings account to each of our Roth IRA accounts. At first, my fear of buying before a stock market crash prevented me from purchasing index-based ETFs with all of our cash, despite the adage that the time in the market beats timing the market. I reallocated the remaining cash to the ETFs only after I realized that I should look forward to better things than the next bear market.
It was my own struggle with lump-sum investing vs. dollar cost averaging.
Since then, we have transferred the maximum contribution amount to each of our Roth IRAs and bought the ETFs with every penny on the first business day of the year, according to our investing policy statement (IPS). This has been possible because, following the aforementioned lump-sum contributions in our first year of marriage, we begin to save for our next-year contributions. We could have bought the ETFs in a taxable account over the course of the year and tax-loss harvested if their values decreased. But we want to ensure that we can contribute the maximum amount on day 1, because once we buy the ETFs in our Roth IRAs, we do not have to worry about them for another 30 years. Until we buy them again on the following year’s first business day, we do not even need to check their prices.
Yes, I did this in January 2022 before the market tanked. And no, I don't regret it.
Because I struggled with my first attempt at lump-sum investing, I understand the dilemma that people face when they ask about “lump-sum investing vs. dollar-cost averaging(DCA).” On the WCI Forum and Reddit, the question often starts as, “I received $XX,XXX as a gift/inheritance/bonus…” (the answer is that you should fund other things beforehand.) Although numerous blogs and podcasts have addressed this question, new threads continue to appear. Crowdsourcing the answer under anonymity is an excellent way to receive free advice on personal circ*mstances that one cannot share with coworkers or even friends. Yet, among “financially correct” comments that have been repeated in similar threads, the original poster may be searching for one that validates their current behavior.
As humans, we tend to either think that we can beat the odds, or we fail to comprehend the odds. It fuels the gambling industry and lotteries. It prevents people from flying on commercial airplanes while they drive their cars over the speed limit. Likewise, many investors (including myself!) want to defy the experts who claim that lump-sum investing outperforms DCA, with the latter defined as “investing all of your available money over time.” Critical thinking has no chance. We cannot resist thinking that we are not like an average investor.
But those of us who have committed to lump-sum investing must keep chipping away at this wall of fear, inertia, and/or overconfidence. One may be reluctant to reallocate their cash after completing a Backdoor Roth IRA conversion in January or determining how much they can contribute to their solo 401(k) in April. In this column, let's discuss five things that we can tell ourselves when we struggle to choose lump-sum investing over DCA.
#1 We Are Not Investors
We are not investors. We are a doctor, a future doctor, or another non-financial professional. We happen to have enough interest in personal finance to manage our own money. As Cullen Roche argues, we should think that we are reallocating our cash to buy assets rather than “investing” it.
Wherever we are, most investing talk is junk. Others' words will go in one ear and out the other because we do not think of ourselves as an investor. We are going to overhear our coworkers talk about stocks and brag about how they are outperforming the market. Good for them. They are going to complain about inflation and taxes. So be it. Our hospital gym is going to have CNBC on the TV, quite possibly Jim Cramer. May I change the channel? If we think that we are an investor, we will be an average investor who underperforms the market because we will let their words make a pitstop between our ears.
The irony is that I am writing for The White Coat “Investor.” But if you look at his IPS, Dr. Jim Dahle is more of a bandwagoner than a trailblazer when it comes to buying the stock market. Why? Because the only way to be better than the average investor is to allow other investors to give you the average return of the stock market via a broad-market index fund. If we save at least 20% of our gross income and take appropriate risk, we should have no trouble reaching financial independence with the historical average return of the stock market. The sooner we reallocate our cash and hitch a ride (and NOT think we are investing it), the less likely we are to be left behind.
#2 We Can Be the Owner of Our Money (and Not the Other Way Around)
We may be a cog in the wheel when we’re trainees, but we do not have to be an employee at the side job of managing our money. When we have money in our checking account, we will be tempted to work with the money. But that is not the mindset of an owner who does not have to work every day. We can be the owner that hires our money to work at the stock market all the time (without commuting back and forth to our checking account or reporting to us daily). Be the owner/employer that we want in our day job by not micromanaging our money.
Our day job will also be a greater source of income than our side job until we reach a “break-even point.” As trainees, we should focus on our day job with the goal of (1) becoming the best physician that we can be and (2) educating ourselves on personal finance, and if applicable, the business side of medicine. As long as we maintain minimum supervision (i.e., sending our money to their job as soon as possible), our side job will be flourishing by the time we graduate from our training 4-8 years later.
#3 We Can Maximize Our Hourly Income
After complaining about how you make less than minimum wage during residency, don't you want to maximize the hourly income of your side job? If we spent one hour on the first business day of 2021 (1) transferring the maximum contribution amount to our IRA account and (2) buying VTI/VTSAX (or FSKAX) in lump sum, we made at least $90 in one hour ($6,000 x 1.51% annual dividend yield). Many of us would take any job that advertises pay greater than $70-$90/hour for clicking some buttons.
#4 We Only Live Once
The idea that time is the most valuable resource that money can buy is not an original idea in personal finance. If you already worked on New Year’s Eve or New Year’s Day, you should have had enough reminders that life is short by the time the stock market opens on the first business day. How much do you value one hour of rest? How about one hour of family time? If we automate our investments throughout the year and we finish our manual contributions on the first business day, then we free ourselves from time spent on: (1) thinking about investments, (2) thinking about investing, (3) actually investing, (4) second-guessing ourselves after investing, and (5) thinking about investing better the next time. Such thoughts are not worth our time.
#5 We Won’t Notice the Difference Later
Writers like Nick Maggiulli have shown that buying the dip does not work in the long-term, but given our recency bias, I will use numbers from the first half of 2022 to hammer home a point. What would be the impact of hypothetical DCA strategies on our journey to financial independence (e.g., shorten it by a few years)? Let’s compare the performance of the following strategies in 2022 (Table 1):
- Strategy #1: buy $6,000 VFIAX on day 1 (“lump-sum”)
- Strategy #2: buy $3,000 VFIAX on day 1 and DCA the rest at the end of each month (“half-and-half”)
- Strategy #3: buy $500 VFIAX at the end of each month (“DCA”)
- Strategy #4: buy $500 VFIAX on the day the price bottoms for the month (“Perfect DCA”)
With the Perfect DCA strategy, our unrealized loss would be $1,000 less than that of the lump-sum strategy (-$1,264.17 vs. -$207.31), and we would still have $3,000 to “buy the dip.” Successfully buying the dip every month is almost impossible, but let us entertain the idea. On July 1, we decide that the stock market has fallen enough and that we will buy lump sum. What would be the difference in our portfolio in 2052, assuming 10.5% annualized return? About $21,000. Or about an attending physician’s monthly (or even less than semi-monthly) paycheck.
This comparison also assumes that we can predict whether the new year is going to be like 2021 (when the S&P 500 returned 28.41% including reinvested dividends) or the first half of 2022. We will have more years that are not like 2022 during our working years. The DCA strategies above are neither worthwhile nor sustainable.
I hope this column encourages more readers to reallocate their cash on Monday, January 2, 2023; or if they have excess cash now, as soon as possible. After you buy index funds in lump sum today, their prices might plunge tomorrow. But if you have the right identity and mindset, you will not check the prices tomorrow. The next time you try to buy index funds in lump sum, you will not have any regrets. You might even be pleasantly surprised.
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How do you decide between lump-sum investing and dollar cost averaging? What's your preference? Why do you feel that's the best move? Comment below!
