This is a question I get asked a lot. It is often asked by people who have just gotten a lump sum, either due to a lay off or inheritance. Should I put the money in in one go as a lump sum, or gradually? Maybe investing it in 2-3 installments to make it `safer` or monthly.
Investing monthly to reduce volatility is called `dollar cost averaging` (DCA). Really just a fancy way of saying it is good to invest every month to reduce volatility and risk. But what does the evidence suggest is the best strategy?
Vanguard produced an excellent study. They looked at the US, UK and Australia, assuming 1,000,000 (1M pounds, 1M dollars and 1M AUD) is immediately invested into a stock/ bond portfolio and then held for 10 years. They then compare the ending portfolio values from each strategy to determine how each performed during the 10-year period.
They repeated the comparison over rolling periods. For example they looked at the U.S. markets from January 1926 through December 1935, the second covers February 1926 through January 1936, and so on until 2011.
They repeated the analysis for various stock/bond allocations ranging from 100% equities to 100% bonds, and for various holding periods ranging from 1 to 30 years. Finally they calculated the probability and size of greater wealth accumulation in one strategy versus the other, as well as the risk-adjusted returns for each strategy.
The results are below:
|Asset allocation||United States (1926 –2011)||United Kingdom (1976 –2011)||Australia (1984 –2011)|
|100% equity||66% of the time lump sum `won`||68% of the time lump sum `won`||62% of the time lump sum `won`|
|60% equity – 40% bonds||67% of the time lump sum `won||67% of the time lump sum `won`||66% of the time lump sum `won`|
|100% bonds||65% of the time lump sum `won||61% of the time lump sum `won`||58% of the time lump sum `won`|
So there you have it. Don’t be worried about volatility. Just invest whenever you have a lump sum and don’t try to time markets.
Adam Fayed – International AMG – firstname.lastname@example.org