Determining Your Lump Sum Strategy
Should you invest it all right away or in smaller increments over time, a strategy known as dollar-cost averaging? Investing in a lump sum comes down to the question of your risk tolerance.
All at once
Research from Vanguard shows that investors would do best by immediately investing in a lump sum. The simple explanation is that markets tend to go up roughly three out of every four years. Vanguard looked at a 60/40 stock/bond portfolio in the US, UK and Australia. It compared the performance of an immediate lump sum investment over a year against 12 monthly purchases spaced out over a year. The lump sum beats dollar cost averaging about two-thirds of the time and by an average of 1.5% to 2.45%, depending on the country. The results were even more pronounced for longer time horizons.
Investing all of your money at the same time is advantageous because:- You’ll gain exposure to the markets as soon as possible
- Historical market trends indicate the returns of stocks and bonds exceed returns of cash investments and bonds
- When markets are going up, putting your money to work right away takes full advantage of market growth
Slow and steady
Dollar-cost averaging is a strategy that allows an investor to buy the same dollar amount of investment at regular intervals. The purchases occur regardless of the asset’s price. When a stock or asset is down, think of it as being on sale – your dollar buys more of it – and vice versa.
Dollar-cost averaging is a tool an investor can use to build savings and wealth over a long period. It is also a way for an investor to neutralise short-term volatility in the broader equity market. A perfect example of dollar-cost averaging is its use in 401(k) plans and US retirement savings plans.
Dollar-cost averaging may be for you if you want to:- Minimise the downside risk of huge investment
- Take advantage of the market’s natural volatility by lowering the average price you pay for shares
- Avoid feelings of regret if the market takes a downturn after you invest
Or wait and see
Delaying investment is a form of market timing, something few investors succeed at.
