If you’re sitting on cash to invest – either because you jumped out of the market at some point or have come into a windfall – it can be difficult to decide how to proceed.
In these volatile times, sinking a chunk of money into equities might not be everyone’s cup of tea. But studies show and experts say that lump-sum investing – rather than the bit-by-bit approach – is the best way to go, if you have the stomach for it and funds to commit for the long term.
“You’re more likely to get better returns by investing a lump sum,” says Tina Tehranchian, a certified financial planner at Assante Capital Management Ltd. in Richmond Hill, Ont.
Research from Vanguard Group Inc. analyzing data in the United States, Britain and Australia shows that in upward-trending markets, it’s best to invest in one fell swoop. A Vanguard study released last year found that lump-sum investing beat dollar-cost-averaging strategies – in which scheduled investments are made over a period of time – on average two out of three times.
Investors in the United States with a 60/40 portfolio mix of stocks and bonds earned 2.3 per cent more over 12 months using lump-sum investments, the research showed. Compounded over 20 or 30 years, such a difference can become substantial.
Many investors are nervous about committing to volatile equity markets, Ms. Tehranchian says. Some who pulled out during the crash of 2008-09 have “totally missed the boat” and now must determine the best strategy for reinvesting. “Having money in the market is better than sitting on the sidelines with cash and being afraid to get in,” she says.
Even though dollar-cost averaging is not as effective as a lump-sum strategy, it is a good option for hesitant investors, she says. “It allows you to dip your toes and slowly commit,” although the money shouldn’t trickle into equities for more than a year. “You’re just reducing your chances of taking advantage of gains,” she says.
Dollar-cost averaging can also “work against you in a bull market that’s moving up; you can really get behind,” she says. But it can give better results in choppy times with sideways movement. “At the end of a year, you could end up in a better position.”
Sandra Abdool, a regional financial planning consultant at Royal Bank of Canada in Burlington, Ont., says it’s always better “that as you accumulate the money, you head into the market with it.”
For those who have been on the sidelines and now have a lump sum, it’s critical to determine why the investor exited the market in the first place. Investors then should determine what the money will be needed for and set a timeline for its use. Then they need to create a strategy for getting back in the market – and stick to it.
“The longer you wait to get into the market, the greater the potential loss you’re incurring from loss of growth,” Ms. Abdool says.
Money invested in equities should be meant for a long-term purpose that’s perhaps 15 years or more away, such as retirement, rather than a down payment on a cottage in the next couple of years, “which is a totally different conversation,” she notes.
Ms. Abdool suggests that investors who are nervous about jumping in all at once should “stage” money into the market in four automatic, equal parts over 12 months. “It takes away the stress, it keeps the investing process very simple,” she says. “The whole idea of trying to time your entry into the market is removed.”
She also stresses that, although volatility is inevitable in any equity investment, “in the long term, volatility isn’t going to be an issue with your growth.”
Ms. Tehranchian agrees. “Short-term fluctuations are going to work themselves out,” she says.
She predicts, however, that markets will be more turbulent ahead than they have been over the past decade.
“Lump-sum investing has a much better chance of giving you a better outcome,” she says, “provided you can handle the short-term risk, and you won’t lose sleep.”