Lump Sum Investing vs Cost Averaging Into ETFs

Today we’re discussing an important topic you keep asking me about on a regular basis.

What is better: Lump sum investing (investing everything at once) or cost averaging into the stock market, more specifically ETFs?

After all, whenever the market drops by a few percent you might be wondering if this is the right time to go all in or if it’s better to slowly move the amount you wanted to invest into ETFs over a certain period.

Perhaps you had some cash on the sidelines you were waiting to invest at the right moment. And now you’re feeling nervous about it because we’re still in a difficult economic environment, with high inflation and unexpectedly high interest rates by central banks.

I completely understand that feeling, so let’s try to figure out the best course of action!

Please don’t forget that none of this is investment advice, just my personal opinion based on my own experience as an investor.

Lump Sum Investing

Let’s begin with some basics first. What the heck is lump sum investing in the first place?

Here you invest a larger sum of money all at once, usually as soon as you made the decision that this is the amount you want to invest in this asset class long-term, in our case stocks in the form of ETFs.

So let’s say you have 15.000€ you want to invest into ETFs:

You simply place an order for 15.000€ worth of shares of your favorite ETF right away and that’s it, you’re fully invested.

You sit back, relax and let the market do whatever it’s going to do, fully aware of the fact that you have no way of knowing what’s going to happen in the short-term anyway and that all-time highs are not a reason to stop investing.

Cost Averaging

Meanwhile, with cost averaging you invest the total sum over time, split into equal amounts which you allocate to your ETF on a monthly basis, no matter if it’s up or down at the time.

Perhaps you prefer this option because you feel anxious about the market right now and you believe your ETF is likely to fall in price in the short run.

You may know this strategy as DCA or dollar cost averaging, but since most of you watching are based in Europe (me included – hello from Austria) and euro cost averaging sounds kind of strange, I decided to just stick to cost averaging as a term. I hope that’s alright with you guys!

Using the same amount like in our previous example, 15.000€, a cost averaging strategy could look like this for instance:

• You could invest 5.000€ each month for three months
• 2.500€ each month for 6 months
• or extend the period before you’re fully allocated by investing 1.250€/month for a year.

Lump Sum investing – Pros

Ok, let’s now look at the pros, followed by the cons of lump sum investing.

1. Likely better returns

Ever heard of the saying time in the market beats timing the market?

By placing a lump sum investment all at once your money has more time to grow and on average, you end up with better returns compared to cost averaging.

That’s because based on history, the market trends upwards over time and is up more often then it is down. For example, since 1979, so over the past 44 years, the MSCI World index was up 75% of the time at the end of the year and up 65% of the time on a monthly basis.

The same is true for the FTSE All-World which is my favorite way to invest globally via one ETF. Since 2003, it was up 79% of the time on a yearly basis and in 64% of the months.

So historically speaking, the odds are in your favor when you invest your money all at once instead of waiting or spreading it out.

2. Only one decision and action needed

Advantage number two is that it only requires a single decision and action, which will likely save you time.

After all, remember to keep the opportunity cost in mind of you researching, spending time thinking about the right time to invest, how to split up your investment for a cost average strategy etc.

The thing is, based on YouTube analytics, most of you are in a similar age bracket as me. So chances are, you still have the best earning years ahead of yourself and whichever amount you’re currently wasting time deciding over is only a small amount of what you’ll likely earn and invest over your life-time.

So is it really worth it to stress out about the exact timing of this one investment? I think sometimes it helps to zoom out a bit and put things into perspective.

It might even help you to calculate your hourly rate from your job, to find out how much your time going back and forth on this decision is costing you in euros.

This may feel like a life-changing decision, but most likely it’s not. At least that’s how I view things.

Lump Sum investing – Cons

Ok, now let’s get to the cons of lump sum investing.

Risk of bad timing

Since there is no way to know in which direction the market is going to move in the short-term, there’s always a possibility that you could be investing right before a correction or even a crash.

There is no way to eliminate this risk and sometimes crashes can take years to recover from.

This is the main reason why I always try to mention that you should treat ETFs as long-term investments, your time horizon should be at least 5 years, ideally 10 years or more.

Emotionally, seeing your portfolio in the red can be difficult if you’ve never experienced this before. Many people get discouraged, start reading news headlines (which are all negative when the markets are down) and may even end up selling at a loss during a period like this.

Meanwhile experienced investors tend to buy more, as they see moments like that as opportunities to get more shares for the same amount of money compared to when they were at their all-time-high.

If you’re in a situation like this, where your portfolio is down, I find it really helpful to look at long-term charts, to see what happened after similar periods of time in the past. Chances are, it will help you calm down and stay focused on the long run.

Cost Averaging – Pros

Now let’s look at the pros of cost averaging:

1. Emotionally easier

Psychologically, splitting up a large sum of money and investing it at regular intervals over a 3, 6 or 12 month period instead of all at once could be easier to handle for many people.

2. Better returns if the market drops

If the market goes lower while you’re cost averaging, you could end up with more shares for the same amount of money compared to a lump sum investment.

3. Builds investing habit

By buying shares for a certain sum of cash on a fixed date every month, no matter how the market is doing at the time, you’re building a great habit that is likely to pay massive dividends over your investment career.

The same is true for lump sum investments by the way, if you keep investing regularly afterwards and don’t get discouraged as soon as you experience a year with negative returns.

Cost Averaging – Cons

As for the cons of cost averaging:

1. Worse returns in rising market

If the market goes up on average while you’re cost averaging, which it statistically does more often then not, you will underperform compared to investing all of the money at the start.

2. Does not eliminate market risk

You’re still exposed to market risk when cost averaging. While it may feel better emotionally to invest the large sum over time in smaller chunks, a crash or correction you were trying to protect yourself from could very well happen at the end of your cost averaging strategy.

There is no way to avoid this risk.

3. You may quit halfway

Compared to a lump sum investment, you run the risk of never fully investing your money if emotions get the better of you during the period you chose, for example if the market drops and you see your ETFs in the red.

Or alternatively, if the market has gone up too quickly in your opinion and you “just want to wait it out”.

If you don’t automate your cost averaging strategy, you may get tempted to try and time the market in the end, which doesn’t work out too well most of the time.

4. Higher fees

The last con is that you’ll likely pay more in fees overall since you’ll need to place a lot more ETF orders compared to just making one large purchase.

Then again fees have become so low nowadays (often around 1€ using the best low-cost brokers in Europe), so it’s not as big of a con as it used to be just a few years ago.

Which Investment Strategy is Better?

Ok, now you’re probably wondering which one of the two strategies is better.

As we’ve established, lump sum investing outperforms in rising markets and cost averaging outperforms if the market is on the decline during your investment period.

Since global stock market indexes like the MSCI World or the FTSE All-World have been up more often then down historically, both on a monthly and yearly basis, you’re likely better off going with a lump sum investment as soon as you made the decision to invest a certain amount of money.

A research paper by Vanguard titled Cost averaging: Invest now or temporarily hold your cash?, where they looked at investment periods from 1976-2022 came to the same conclusion. Here they compared a lump sum investment with a 3-month cost averaging split using the MSCI World index.

68% of the time you were better off with a lump sum investment compared to cost averaging, with investors experiencing a median extra return of about 2% during the first year:

But I’ll be the first to tell you that’s easier said than done emotionally.

Chances are, as long as you don’t stretch out your cost averaging strategy too long (I think a 3 month period is ideal as chosen by Vanguard for their study), it’s not going to make that much of a difference when looking back a few years later, no matter which direction the market moves.

The reality is, no matter what strategy you choose, there are no risk-free returns in the stock market, corrections and crashes are part of the journey.

The only way to effectively reduce the risk of negative outcomes is to stay invested over longer time periods.

And no matter which of the two approaches you settle on for your initial investment, continuing to cost average some of the monthly income from your job into a well-diversified low-cost ETF can still be a very effective way to grow your portfolio further.

That’s what my wife and I have been doing as well on a monthly basis since 2017, which helped our investments in ETFs grow to a significant size since then, getting us closer and closer to our goal of being able to retire early one day.

Who knows, you might even reach a point where you get excited when you see the market decline, as you learn to view it as an opportunity to get more shares of the best publicly listed companies at a discount.

As for myself, even after knowing the data I’d love to sit here and tell you I simply invest a lump sum into my favorite ETF, the Accumulating Vanguard FTSE All-World right away as soon as I have a larger amount of investable cash, for example my wife and I recently received a combined total of 8.000€ in tax refunds for 2022.

But the thing is, most of the time even I split up amounts like that and invest them in a few chunks instead of all at once. Did that yield better returns when looking back than just throwing it into the market at once right away? No, most of the time it did not!

I just wanted to tell you I fall into the same market timing trap sometime, thinking I might be able to get a few more shares for my money if I just wait a little more or don’t invest it all at once. The good thing is, I still end up investing the full amount within a month or two, so I make sure I don’t take it too far.

Alright, now let’s take a look at some of the best ways to implement each strategy:

How to Lump Sum or Cost Average into ETFs in Europe

If you’re going for a lump-sum investment of a large amount of money right away, I would definitely pick Interactive Brokers, my personal number one low-cost broker in Europe.

On IB you can choose between two pricing models, tiered and fixed in your account settings.

Here is a Google sheet you can use to calculate the fees using each model to help you with your decision based on the amount you’re planning to invest. Just create a copy first, then you can edit the numbers.

Orders are pretty straight forward once you placed your first one and many ETFs, including my favorite the Accumulating Vanguard FTSE All-World now come with fractional shares as well, which means you can fully invest whichever amount you’re planning to allocate to ETFs right away.

Additionally, Interactive Brokers recently added recurring investments as a feature. These come with the exact same low fees as direct purchases and also include fractional shares.

I currently have one running at the start of each month, which helps me save some time and automate my investments.

The one caveat for me would be regular orders below 500€ each, for those I recommend looking at the other two brokers in my top 3, Trade Republic and Scalable Capital.

That’s because once you go below that amount, let’s say for example you want to invest 250€, then even a trading commission as low as 1,25€ on Interactive Brokers already makes up 0,5% of the investment amount. And if you’re only buying 100€ worth of shares, you’re already at 1,25%, which based on an average yearly return of 7% per year for the FTSE All-World for example, would take you about 2 months to recover from on average.

Meanwhile, both Trade Republic and Scalable Capital offer commission-free saving plans into thousands of stocks and ETFs including fractional shares, which is fantastic if you’re only able to invest smaller amounts on a regular basis right now.

As a result, I currently have a small ETF savings plan for my 10-month old daughter on Trade Republic and my wife has an ETF savings plan on Scalable Capital at the start of each month, as she loves how easy that makes investing for her.

Lastly, I’m not sure if this works for all investors, but at least in our case we’re able to set up the saving plans on these two brokers in a way that they collect the money directly from our external personal bank account for free before executing our commission-free recurring investments.

It’s a great way to really automate everything from start to finish. This is the one feature Interactive Brokers is still missing, hopefully it’s coming at some point.

You can find a more detailed video guide on each of the three brokers here.

Conclusion

Alright, hopefully I was able to cover most of the questions you had about lump sum investing vs. cost averaging in today’s post.

Ultimately, you know yourself best and you need to make sure you’re able to sleep well at night, so pick whichever strategy you feel the most comfortable with and just get started.

But, once you do make a decision, make sure you stick to it and don’t let your everyday emotions get in the way on your journey towards achieving your long-term financial goals.

Also, if you’re in a similar age bracket like me, as most of you seem to be according to YouTube analytics, try to put things into perspective. Chances are, you still have your best earning years ahead of yourself and whichever amount you’re currently wasting valuable time deciding over is only a fraction of what you’ll likely earn and invest over your entire life-time.

So is it really worth stressing about what the market might do in the next few months, something you have zero control over, keeping in mind that you’re fully exposed to market risk towards the end of a cost averaging strategy as well?

This may feel like a life-changing decision, but most likely it’s not.

Just make a decision on how to proceed, stay the course and move on with your life. At least that’s my point of view.

Now I want to hear from you:

How do you usually invest large sums of money? A lump sum all at once or do you split it up and cost average the amount into the market?

If you’re worried about buying ETFs at or near all-time-highs, you need to read this post next. You might be shocked by what I found out during my research.