Your worst investing nightmare probably goes something like this: After investing a large chunk of money in stocks, the market tanks.
Recent stock market turbulence reminds us that this is no abstract risk. Stocks have had a great run and will at some point correct. Wouldn’t it make sense to stay in cash until that correction happens?
A reader with $200,000 in a savings account recently asked this question. “While realizing it's not the optimal solution, the market is at its highest in history and will go down, short-term or medium-term. Should I wait for the next downturn to invest or is such a strategy never viable?”
Never is a strong word. Some investors, either by skill or luck, may pick the ideal time to get in or out of the market. But the chances of success are slim. That’s why I suggest a compromise between jumping into today’s unsettled market and sitting idle for as long as it takes for stocks to fall hard. Divide the lump sum you have to invest into four parts and invest them quarterly or so over the 12 months to come.
Academic studies show that lump-sum investments on the whole outperform dollar-cost averaging, where you make regular investments over a span of time. But making a lump-sum investment right now seems ill-advised from both an investing and emotional point of view. Stocks have had a great run (U.S. stocks, at least) and are due for a correction. If you were to invest now and see your investments fall by 25 per cent or 30 per cent, anxiety over your paper losses may lead you to sell to protect against further declines. It’s a lot easier to watch just a slice of your money lose value – losses are limited and you’ll be able to invest the next quarterly slice at reduced prices.
Why not just wait for stocks to plunge and then invest the whole $200,000? Because you probably won’t have the stomach to jump in when stocks have plummeted. It’s widely known that investors should buy low. What we don’t hear much in a scary correction is someone telling us, “Okay, stocks are low. It’s time to buy.”
Rob Carrick