I’ve recently made it a habit to address common and timely questions here on TOM. It seems like when volatility is elevated, I often get this question, “Should I invest my money now or wait?” The concern is that one doesn’t want to invest at the wrong time. In the world of personal finance, the advisor community assumes one of the following, an investor can (1) invest a lump sum all at once or (2) average in over a specified period of time. What option is optimal? That’s the topic for today’s discussion.
So, let’s jump right in and discuss this common inquiry, but first, let’s talk casinos…
I want you to imagine that I have never heard of a casino. I have no idea what a casino is, and it is your job to explain it to me. So, you start by explaining that a casino is a business, a business made up of a collection of games, games of chance. These games pit the customer up against the casino and wagers are placed, a type of organized gambling.
If you left the description there, you would have me scratching my head. Why? Because if these are games of chance and the customers compete with the casino, how do they stay in business? How do they make a profit? There is a very important detail that can’t be left out – each of these “games-of-chance” is slightly tilted in favor of the “house,” the casino. The probability, even if ever so slightly, favors the casino to win.
Slightly favorable odds, multiplied by a high volume of customers and wagers, makes for a profitable business.
The Business of Investing
Investing is not gambling. Some folks may treat it that way, but real investing is not gambling.
Think about our description above, a casino is full of gamblers, but who is on the other side of each wager? A business, the casino. Real investors treat investing like a business, and they seek to put the odds in their favor.
There is something like a 54% chance that markets (e.g., S&P 500) will be positive (return greater than zero) on any given day. As you stretch those time horizons beyond one day, the probabilities tilt event further in your favor.
With that said, let’s address a common question I get asked, “Is it best to invest all my cash at once in a lump sum or dollar cost average my purchases over time?”
Based on what we just expressed above, we might conclude that you should lean into the lump sum option because the probabilities are in your favor, but is this “best” for you?
This question deserves more than a rapid-fire response, it deserves a dialogue. This is the type of question where the different sides of your brain might find themselves in conflict. Your logic side will reference the statistical favorability, while your emotional side will focus on regret minimization.
You might ask yourself a question like this, would I regret my decision about making a lump sum investment if markets dropped 20% next week?
Again, these are questions and dialogues that an investor should wrestle with alongside their advisor. What we know to be true is this: (1) stock prices in the short term are unknowable (2) dollar-cost-averaging only creates a financial benefit if future entry points (future stock prices) are lower (3) dollar-cost-averaging can often create a psychological benefit of not having to be responsible for “perfect timing.”
I will often tell investors that there is not a right answer – lump sum or dollar-cost-average. Using an “averaging in” method is just a tool, and it’s a tool that you resource when you want to ease the tension caused by markets potentially misbehaving early on.
Over my career, I have had conversations with thousands of investors. Along the way, I have collected a lot of stories, both encouraging stories and horror stories. I’ve learned that bad experiences in investing can be souring, and these distasteful experiences can create lasting damage – financially and psychologically.
Part of an advisor’s job, as odd as it is to say it this way, is to help maintain a positive relationship between investors and their stock portfolio. The nurture a positive relationship here, we often need to be sensitive to first impressions. An investor that sold a business or inherited a significant amount of wealth will be stepping into a first impression with their new portfolio.
So, yes, probabilities may lead you to the conclusion that a lump sum gives the best odds for maximizing your wealth today. As an advisor though, you must know your client intimately and decipher whether a potential surprise to the downside early on might sour your investor about being a long-term committed investor. Again, go out and have enough conversations and you will be well aware of all the investing battle scars out there.
Good, we’ve established that this decision will be a balanced consideration of the financial and psychological benefits.
Now, much of what I talked about above applies to someone who is currently sitting on a significant amount of wealth in cash. Again, the source may have been an inheritance, the sale of a business, or even just an accumulation of savings over time that have stacked up.
One variable that you should consider when deciding how to make your initial allocations is the source of where this money is coming from. Coming from a cash or a recent liquidity event will very well produce a different assessment than monies being rolled over from a retirement account or being consolidated from a legacy advisor.
If the “risk exposures” already exist, like a 401(k) fully allocated to equities and if this new portfolio design and plan warrants similar exposures then I would often argue that is doesn’t make sense to go from current risk exposures to cash to waiting to find an attractive entry point to get “back in the market.”
Imagine if a friend sold their primary residence because they felt like housing prices were overvalued. Then they planned to rent for some undefined amount of time until they would buy again. To me, this is a dangerous endeavor, as it is (1) disruptive and (2) leans on our ability to try to pick the peaks and troughs of the markets – an impossible endeavor.
Now, let’s bring this full circle. Maybe you don’t have a pending inheritance or a business you recently sold. Maybe your portfolio was designed some time ago and you are already “fully” invested, does that mean that this discussion offers you no insights? Absolutely not, this discussion is a highlight of a very important investment truth that will serve you well across a lot of your planning decisions,
Here it is, financial planning is full of decisions and our intuition may initially lead us to believe that our sole job is to maximize outcomes (returns). I’d argue that is part of the consideration, but the other half revolves around how we feel. How we feel now or how we might feel in the future.
Leaving out our preferences and feelings from the decision-making process does a disservice to the financial plan. Trying to figure out whether to invest everything today or averaging in over time is both a financial decision and a psychological decision.
As always, I will encourage you to listen to the podcast and please feel free to email any questions, comments, or compliments 😊 to TOM@thebahnsengroup.com.
AND… Most importantly…. I will be back next week with more of my thoughts on money.