Investing a Lump Sum
We are often asked the question – ‘Is it better to invest a lump sum or drip it into the market over time?' From a pure return maximising perspective, the evidence suggests that investing a lump sum in one go is the most efficient way to invest. This is supported by a study from Vanguard (one of the largest investment managers in the world) which states that it is better to invest a lump sum immediately rather than dollar cost average (or in our case euro cost average) as stocks generally outperform cash and bonds and the expected return of stocks (expected not guaranteed) is always positive.
A reason you might decide to average or drip feed into the market over time is to manage the emotional side of investing. For example, if we invest a lump sum and the market drops, we might react (i.e., sell) and crystalise a temporary loss into a permanent one. This is perfectly fine, however drip feeding into the market isn’t a free lunch, there is a trade off in likely lower returns versus investing the lump sum in one go. If you are going to average into the market, what timeframe should you use? Financial commentor Nick Maggiulli, writer of the blog ‘Of Dollars and Data’ (see link below) did some detailed analysis on this. If you are going to average into the market, the longer the period, the worse the outcome. Based on his analysis, if you average in over 24 months you will underperform the lump sum investment option 80.6% of the time and by 10% on average at the end of the averaging period.
As Nick states “The best time to start was yesterday. The next best time is today”
Perhaps another solution is to adjust your asset allocation, maybe move 100% equities to 60% equities/ 40% fixed income (bonds) and rebalance in times of market downturns. In addition, make sure your assets are aligned to your liabilities. For example, money I need for holidays next year should be in cash whereas funds I won’t need for 10 years can likely be in 100% equities – this structured approach to investing a lump sum can get investors comfortable with a tailored asset allocation resulting in more buy in from an investor perspective as they understand the rationale for the approach.
Euro cost averaging is often considered a tactic that should be deployed when investing a lump sum – however, as noted above it is suboptimal. The real benefit of euro cost averaging is where it ties into your cashflow, and you don’t have a lump sum. For example, investing a part of your salary in a pension every month is a very efficient form of euro cost averaging.
In conclusion, if you have a lump sum, rather than considering when to invest it, more consideration should be given to questions such as:
- How much do I need in a cash reserve?
- How much am I spending on an annual basis that will need to be supported by my assets?
- Do I have any big expenditures planned?
- What is the money ultimately for?
If you would like to discuss how this applies to your financial structure please get in touch with the team.
Sources/ Further reading:
https://ofdollarsanddata.com/dollar-cost-averaging-vs-lump-sum/