Earlier this month, I set out to cross off a few items on my 2021 money agenda.
The move itself was simple enough.
Fill out an online form. Wait a few days for the money to be transferred. Chuck it all into VUAG.
Prepare to save thousands of pounds.
In other words, this:
But as I hovered over the “Deal” button, I did catch myself hesitating, if just for a millisecond.
Should I really go all in? The market feels kind of frothy, doesn’t it?
Could it be better to slowly drip-feed all that cash instead of going all in?
Therein lies the inspiration for today’s post.
The Definitive Guide To Lump Sum Investing
The choice between lump sum investing (LSI) and dollar cost averaging (DCA) is one of the most frequent discussions in the personal finance community.
As such, there’s plenty of resources that will give you all the definitions and evidence you need to form an opinion.
No need to repeat things here. For what it’s worth, one of my personal favourites is this guide from the ever-excellent Nick Maggiulli.
If you have a few minutes, I recommend you read it. If you don’t – let me give you the punchline here:
Lump sum investing wins.
Hands down. No ifs and buts. Even if you adjusted for risk, asset classes, and valuations.
It makes total sense – given the market goes up over time, the sooner you get in, the better off you will be.
The evidence simply doesn’t lie – lump sum investing trumps DCA every single time.
But let’s pause for a moment as I ask you an unrelated, hypothetical question.
Where Theory Meets Reality
Assume I was going to offer you a game of Russian roulette.
For ease, let’s also assume the revolver we are going to use has 10 chambers, and I loaded up 9 of them with bullets.
You would clearly be nuts to accept an offer that has a 90% chance of you blowing your brains out.
As a matter of fact, that reasoning shouldn’t change regardless of how many bullets I remove from the revolver.
It’s just as bad of an idea if I leave only four bullets in, which gives you a 60% chance of “winning”. Should you play?
And even if the hypothetical revolver had a 100-chamber cylinder and just one bullet, you’d be well advised to stay away from this highly questionable bargain.
In other words, the risk of catastrophic loss clearly outweighs any potential upside I could possibly offer you.
Now, I am not drawing a parallel here between stock market investing and Russian roulette.
The reason this analogy is helpful, however, is because it clearly illustrates the way our lizard brain thinks about money and probabilities.
Sitting On The Sidelines
Assume you’ve come into a life-changing sum of money.
Empirical evidence suggests that the “right” thing to do is to invest all of it ASAP.
But as long as there is a non–zero chance of (temporarily) losing 40, 50, or even 60% of the capital in a market downturn, with possibly years to recover, is lump sum investing is the way to go?
You’ll have to answer that question for yourself. The answer will depend on things like the quantum of money involved, your risk appetite, preferences, and objectives.
What’s absolutely clear, however, is that being in the market beats not being in the market.
And if DCA is the way you dip your toes in the water, then so be it, all and any mathematical evidence be damned.
The alternative is to sit on the sidelines forever – because lump sum investing terrifies you.
In addition to dealing with sizeable chunks of money, here are a few other situations where DCA can be a way to get off the proverbial fence:
Perhaps you don’t know what you are doing. Not everyone has years and decades of investing experience.
If that’s the case, better to take things slow. Come up with a strategy. Put your money to work in 5-10% increments – and refine your approach along the way.
You might not maximize your gains – but you’re also unlikely to lose any sleep.
Alternatively, you may want to use tax-advantaged accounts.
Depending on the specifics, it might be worthwhile sitting on cash for just a bit longer – but shield your investment gains from taxes forever.
If you do end up going with DCA, you better remember to automate your investments.
Naturally, DCA outperforms in falling markets – which is exactly when you may be reluctant to top up your portfolio. Better to take the emotion out of the equation.
Going All In
Having said all of the above, let’s go back to the original premise of the article.
In case you feel like lump sum investing is the right way to go, but just can’t pull the trigger, it may be worthwhile asking the questions below:
Where was the money sitting previously?
In my situation, the money was already invested in equities. I simply cashed out the portfolio to transfer it to a new broker.
As such, I wasn’t really “lump-sum investing” it in the first place.
On the contrary, choosing to drip-feeding would be the equivalent of cashing out my portfolio.
Does the amount really move the needle?
Everyone will have a different answer here. That being said, 20% of your net worth can be a helpful reference point here.
Assume your net worth is £100k and you chuck £20k into equities in one go. The next day, the market declines by 50%.
As a result, your net worth is down by £10k, or 10%. Unpleasant, but far from terminal.
Are you really investing a “lump sum”?
For most of us, money events like inheritances, lottery winnings, and divorce settlements will be genuine one-offs.
Many others may feel like one-offs, but they actually aren’t. The best example here is an annual bonus.
The amount and timing might vary, but if you’ve been receiving one for years, it hardly qualifies as a true “lump sum”. If that’s the case, might as well chuck it all in and forget about it.
Squaring up theory with emotion is one of the biggest challenges in personal finance.
An answer that makes 100% sense mathematically can make zero sense emotionally. Fighting your lizard brain is rarely a good idea.
Instead, much better to strike a compromise and move on.
Your portfolio will thank you for it.