Friday, November 28, 2014

Lump Sum Investing vs. Dollar Cost Averaging

I wanted to know if it was better to dollar cost average or to make a yearly lump sum contribution when funding an investment account such as a 529 or Roth or Traditional IRA so I put together a couple of tools to help visually explore the data.

In the first viz below we see what monthly dollar cost averaging and lump sum investing look like over a period of 12 months. By default, this viz shows every year from 1950 to 2013. You can see that the investment using lump sum investing starts out with the nominal amount ‘X’ and that the dollar cost averaging strategy starts out with 1/12th of X and steps up as each monthly contribution is made.

For second viz below, instead of calendar years, I've used rolling one-year periods. A year is defined here as 252 consecutive trading days with a month being 21 consecutive trading days. This gives us more than 16k sample periods starting and ending between 1950 and 2014 (partial).

To really get a good feeling for the data, use the sliders at the bottom of each viz to select both what range of years you want to understand and to trim down the data by percentile. For example, if you want to remove outliers you might set the bottom to 5% and the top to 95%. To see what the median looks like, set the top and bottom trim to 50%. Set them at 0% to see the worst days and at 100% for the best.

This particular data-set only takes change in price in to consideration. Some other considerations would be dividends, trading costs, opportunity costs as well as the availability of capital.




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