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Should you take the plunge or wade in slowly when investing?
A perennial investment question we often are asked is, “How should I invest if I have a lump sum of cash? Should I invest it all at once or slowly over time?”
You may find yourself with a significant amount of cash available to invest for a variety of reasons. Perhaps you sold a house or a business, executed company stock options, or you’ve accumulated significant savings at the bank and now have more cash than you will reasonably need in the near future. It can be very difficult — even overwhelming — to decide how and when to invest it. Should you invest today, next week, next month, or over several months or years? The right answer depends on the details of your personal situation and plans. Fortunately, there is good research and evidence that provides some helpful guidance about whether you should take the plunge and invest your cash all at once or wade into the market slowly over time.
We know from historical data that an investment portfolio allocated to stocks and bonds typically has provided significantly more growth over time than keeping cash in the bank and is likely do the same in the future. Additionally, most people are not in a position where cash alone, which pays very little in interest, will provide for their financial security over the rest of their lives. Your goal should be to get invested, whether it is immediately or over some reasonable period of time.
Interestingly, the research is pretty clear. A lump-sum investment usually provides better returns. According to Vanguard, a lump-sum investment into stock and bond markets has provided a higher return over dollar-cost averaging, or investing the same amount of money on a consistent basis, nearly 70% of the time. The reason for this is because markets go up more often than they go down. In other words, the odds are in your favor if you choose to invest a lump sum. You will likely earn more if you invest cash in the markets today rather than wait and invest slowly.
However, wading in may feel more comfortable for some investors, even if the historical data shows that taking the plunge usually pays off in higher returns. If you are fortunate enough to have $1 million in cash, for example, you might feel more comfortable investing your money in increments of $100,000 per month over 10 months. The benefit of dollar-cost averaging is that it can narrow the range of possible outcomes. A systematic approach, such as the one referenced here, is really a risk reduction strategy. While this approach may result in lower investment returns, it also may moderate the impact of a short-term market decline should that happen. Vanguard suggests that if you wade in, do so over a period of up to 12 months. The longer you wait to invest, the higher the probability you will miss out on investment growth.
A common fear many people have is investing after markets have gone up and when stocks are expensive. One influential financial blogger, Ben Carlson, took a look at this. He compared a lump-sum investment to 12 equal monthly investments made into the S&P 500. Based on factors including the CAPE ratio, Carlson determined a lump-sum investment still has been better 60% of the time, even when markets appeared expensive at the time.
It’s valuable to remember that no one can forecast when markets will go up or down. That’s good news for investors because it means you don’t need to spend mental and emotional energy worrying about whether now is the right time to invest. You simply won’t know for sure, and neither will anyone else. As we all know, there are plenty of things in life to worry about, and short-term market forecasting is not something anyone is likely to be good at.
Unfortunately, the financial media is full of very professional looking and experienced people providing forecasts about where markets will be in the next week, month, quarter, or year. Keep in mind the majority of these forecasts are wrong. The reality is that market timing — trying to guess the best time to invest — usually leads to lower returns. And, once again, markets tend to go up much more often than they go down.
Of course, even if the probability is in your favor with plunging, your outcome is not guaranteed. While you may earn more with a lump-sum investment, your range of potential outcomes is wider, and your risk is higher. Short-term uncertainty is the cost of earning the better returns that have resulted from long-term investing.
The goal for most people should be to become fully invested in an appropriate portfolio allocation that will support your needs over the long term. First, focus on your personal needs and plans. Then, if you are comfortable following the evidence, go ahead and take the plunge. Invest your cash when it is available. Or, if wading in feels like a more comfortable way for you to invest, then consider investing systematically over a period of up to 12 months. Either way — wade or plunge — you’ll be in a good position to become fully invested and working toward your long term financial security in a reasonably short period of time.