Clint Thomas, MSF, CFP®

In the many years that I’ve been advising clients I’ve heard both statements in various market conditions; “The markets look uncertain and scary, I don’t want to invest until the skies clear” and “The markets look uncertain and scary, I want to invest cash now”. So, which statement is correct? At some point, investors may receive a lump sum of cash such as a sale of a business, inheritance or divorce settlement and correspondingly need to make decisions of how to invest it as well as whether to invest the funds all at one time or systematically over time (commonly referred to as dollar-cost-averaging). There are a few considerations to keep in mind when it comes to whether to invest cash into a diversified portfolio all at once or systematically.

History supports an immediate lump-sum investment has outperformed systematic implementation strategies across global markets. In a recent study, Vanguard compared immediate and systematic investing of a 60% stock/40% bond portfolio in the United States, United Kingdom, and Australia. For the systematic plan, cash was invested in 12 equal monthly installments and the returns were evaluated across rolling 12-month historical periods. The results of the study indicated that an immediate lump-sum investment led to greater portfolio values approximately two-thirds of the time. These findings are not surprising since stocks and bonds have historically produced higher returns than cash, as compensation for their greater risk. However, many investors fear that there will be a market decline right after they invest and don’t want to risk watching their portfolio fall and opt for a systematic implementation of the investment plan. The systematic investment of cash over time can be used as a risk-reduction strategy since it moderates the impact of an immediate market decline. This approach may help an investor “sleep better at night” knowing that if the market has a downturn the monthly investment will be able to take advantage of the dips and buy in at lower prices. However, historically the trade-off has been a lower return in the majority of market scenarios. So, although a systematic investment plan may make you feel better, in most cases you will be giving up some return. With a systematic investing plan, multiple trades will be placed so additional trading costs should be factored into the decision as well. Also, keep in mind that while the dollar-cost-averaging plan is being implemented the portfolio will be temporarily out of alignment with the long-term asset allocation. Therefore, it is not recommended that a systematic plan lasts longer than 12-15 months.

So, what happens when an investor does not want to set up a systematic investment plan but wants to take advantage of investing when they see dips in the market? They may not realize it, but they are trying to time the market and that simply doesn’t work. The common problem that arises is when there is a dip in the market the typical investor either gets scared and doesn’t want to invest because things don’t look rosy, or they think there will be even more declines so they choose to wait and invest when the market bottoms. Both of these views inevitably lead to the wrong decision being made at the wrong time. Therefore, if a systematic investment plan is going to be implemented it needs to be truly systematic in that there is no timing decision involved. Set the investment at the same time each month and don’t alter it based on what’s going on in the news or world events.

While market history supports that immediate lump-sum investment outperforms a systematic investment plan, the “sleep at night” factor should also be considered and discussed with your financial advisor as to the best option for you and your individual situation.