You won the lottery, inherited a large sum, or sold your company… in short, you came into a substantial amount and want to invest it. The first question that arises in such cases is whether it is advisable to invest the entire amount or distribute it over time in installments.
The answer is depicted in the following chart:
The graph above shows the percentage of time that a distributed (Dollar Cost Averaging) investment outperforms/underperforms a lump sum, immediate investment. It examines the relationship between distributed (in equal monthly installments) and lump-sum investments over a period of 2 to 60 months. The answer is clear: lump-sum, immediate investment is the winner. Markets tend to rise for the majority of the time, and this cannot be offset by the distributed investment method, which prefers lower risk exposure.
It is also evident that the longer you stretch the investment over time, the worse off you will be. At two months (which doesn’t make much sense anyway), time covers only 65%, while at 60 months, it covers 95%. The more cautious you are, the worse off you will be.
The chart presents the numbers for a 60/40 portfolio formed from the US SP500 and 5-year treasury bond combination, and more informed readers may question how applicable this is in other cases (the U.S. stock market being one of the best-performing markets in recent decades). Vanguard examined this question for two other countries (England, Australia) and reached precisely the same result. The numbers differ slightly; the average outperformance of lump-sum investment is 1.45% in Australia, 2.03% in England, and 2.39% in the USA. Also, according to Vanguard, the asset allocation (equity/bond ratio) does not significantly influence the final result. So, if we don’t touch something performing very poorly in the long term, it generally makes sense to choose lump-sum, immediate investment.
Of course, rational solutions are often overridden by fears. In recent years, I have often heard that many are unwilling not only to invest a large sum but any amount at all because the market is expensive. Still, let’s see what happens in the case of expensive markets. Fortunately, others have done this for us, so the result is enough: even in expensive markets, lump-sum investment is better. In such times, the risk is noticeably higher, and there is a more significant chance of a bad outcome, but in 60% of the time, we are still better off with an immediate lump-sum investment.
However, these are just numbers. Investing is not a mathematical operation but an activity strongly influenced by the psyche. Distributed investment takes the weight of a significant decision off our shoulders. Choose this solution calmly if you are on the brink of fearing the possibility of a larger drop. Try to find an investment period tailored to your own comfort but not stretched too long. Let’s not forget about the risks of distributed investment. We may now think with a calm heart that we will discipline ourselves to buy in a falling market (buying in equal monthly installments is truly advantageous in such periods), but when we get there, won’t we be just as scared as we are now of an expensive market? Continuous investment takes more time and energy than diving into the stew immediately and then going about our business, dealing with life’s other challenges.
Dominic Feron 