“I have a big pile of cash. Should I go all in or invest it a bit over time?”
Without exaggerating I’ve seen this question hundreds of time. Is there a right answer?
Dollar Cost Average vs Lump Sum
So you have this load of cash – maybe you got a bonus or you just weren’t sure what to do with your savings and it built up over time. Now you want to invest it.
You could either throw the whole lot in at once (lump sum) or put part of it to work each month for the next 6-12 month or whatever. Which option will result in the greatest investment return?
Well – we won’t know until after the fact. Bummer, that, but what can you do? If one option means you take action vs doing nothing, then that is the right choice.
But… 90 times out of 100, lump sum will win. “Time in market is more important than timing the market.”
Or as Vanguard says, “Our research indicates that it’s prudent to invest a lump sum immediately.”
(That research has been in the form of a white paper, but all links I checked were broken. If anybody has a link I will add it here.)
Lump Sum
Why lump sum? The common retorts are:
“What if the market drops right after I make a big investment?!”
and…
“The market is at all time highs! I don’t want to invest my whole cash hoard at these prices!”
Might the market drop immediately after your big purchase? Yes, certainly. That is what happened after my lump sum investment in 2007 after all. (Worked out ok anyway.)
But the more probable scenario is that the stock market continues to rise, because the markets normal status is to be at “all time highs” and “record prices.” So says the chart.
Data from multpl
When the market continues upward after your initial investment, dollar cost averaging just means your average cost is… higher.
Exceptions
For early retirees, sequence of return risk is of utmost importance – basically, you don’t want to retire into a sustained down market. This is what hurt people who retired in 1929, 1965, 2000, etc… and is why “the 4% rule” is not the 5%+ rule.
Or… it is what happened with Japan’s Lost Decades. One of the key lessons from this time period is, “Don’t go 100% cash to 100% stock at extreme valuations.”
Isn’t this the opposite of the idea of lump sum being better than dollar cost averaging? It is.
In the event that you are 100% cash (why though?) and you have been sitting on the sidelines as the market has gone up, Up, UP for the past many years (ahem), AND valuations are extremely high (maybe CAPE is something silly like 40+) and retirement is imminent, then dollar cost averaging may bring superior results…
data from multpl
Money Where Your Mouth Is
We recently got a mortgage on our fully paid for home. (Related: Getting a Mortgage Without a Job)
I immediately put the majority of that mortgage check into the market. Lump Sum.
Whether this wins in the short term is a question of whether the market tanks in the near future.
But so far the total return after expenses is about 7% in a bit over 3 months.
Anecdotally the lump sum investment is faring better than the wait and see approach – had I waited, I would have missed 2 dividend payments and a rise in market prices.
Summary
To lump sum or dollar cost average is a common question.
Because the market trends in the upward direction, lump sum investing will often outperform dollar cost averaging. So says Vanguard and others.
That is what we have done historically, including recently with a cash-out mortgage refinance.
There is an exception – were we at 100% cash and planning to retire early in short order, years away from Social Security, I would be less aggressive.
I did an experiment where I tried each method for a year and was dramatically worse with lump sum investing. In part because I got very Gollum with the pile of cash but also because they weren’t comparable methods considering the income source.
I was doing lump sum using income that came from our regular paychecks, so it took time to build up a lump sum which is rather the opposite of how we come to having lump sums, right?
I’ve settled into an aggressive weekly investing schedule instead. Still draws money from our paychecks twice a month AND regularly dumps money into the market weekly rather than holding it until we have bigger amounts. I think this plays to the lump sum method’s strength of increasing time in the market with whatever we have available.
Yeah trying to create a lump sum scenario by just hoarding cash for a long period of time seems like the worst of all options
Yeah the idea was to experiment but it was poorly designed for that purpose. XD
In any case, I did learn an important thing about my investing behavior so that was good info to inform my actual plans.
Jeremy, I downloaded the Vanguard white paper a few years ago and posted it to my site. https://militarymoneymanual.com/wp-content/uploads/2021/08/Dollar-Cost-Averaging-Just-Means-Taking-Risk-Later-Vanguard.pdf
sweet, thanks
You are right about lump sum anyway when the markets are at all-time highs and the CAPE so high I always have a strange gut feeling and rather prefer DCA even at the cost of the investment appreciating less. Anyway good for you with your mortgage!
so far so good. But then again the market could drop 7%+ tomorrow. Long term probably still works out
Here is an excellent data-based analysis, which supports your conclusions above.
https://ofdollarsanddata.com/dollar-cost-averaging-vs-lump-sum/
Don’t wait to invest, just invest. The only time it may be worth holding off is if there are other short-time goals that the money needs to be used for, but even that money can be put in a higher interest saving account until it is needed.
100% this. We sit on a five-figure pile of cash for just-in-case problems because 1) they happen frequently in a 100-year-old house (as I listen to the excavator currently replacing our sewer line) and 2) it keeps my wife happy, but every payday the first thing I do is throw a big portion of it right at Vanguard.
Having a degree of diversification is more important than timing the market, which no one is capable of consistently. I know that someone will say “I put all my chips on Bitcoin and now I am sitting on my 100 foot yacht in the Aegean”. Yeah, it can happen, but how many people (especially those nearing retirement) are going to take that chance? Good luck to all in 2022!
I will be getting a lump sum from the sale of my home. I will be doing a mixture by fully funding a Roth IRA up front, but will dollar cost average the rest through maxing out my 457 account. The tax savings are too good to pass up. (I would not otherwise be able to max out my 457.)
Seems reasonable. If income is low just make sure the marginal tax rate on the 457 contributions is good enough.
457s are pretty much the best! No early withdraw penalty. So they are a great way to tax arbitrage. (Some employers even offer a 457 Roth).
Even thought it “feels” like a terrible idea to go all in at once, I’ve managed to (mostly) go all in when I’ve had that lump sum. It’s hard!
I’ve always wondered about the reverse, however, when it comes to withdrawals in RE. Intuitively “time in the market” suggests that I should make those withdrawals monthly – in effect a “reverse-DCA” manner, right? Rather than withdrawing a lump sum of cash for the coming year’s expenses in January. Your thoughts?
I do it annually – its more convenient. See: Cash Flow Management in Early Retirement
I agree. Lump sum. It’s an algo for me. I don’t debate it anymore.
BTW, relative of mine inherited money in 1999 (close to the top of the internet bubble). She DCAed in over 18 months, cognizant that we were in a bubble–but still managed to invest throughout all of the top before US stocks crashed!
The point is: DCAing might mean you just buy slowly at higher and higher prices–and then the market tanks. That’s what happened to her. Of course, it’s more complicated because she had corporate bonds and emerging market stocks then which zoomed as the crash hit.
Regardless, the money has more than quadrupled since then (not factoring in inflation)–and I’m glad she invested it.
On a separate note, not investing now also exposes holders of cash to major inflation risks. Pick your poison.
Cheers!
I hear inflation is high now and risk free rates are not so good.
When is the best time to plant a tree? 25 years ago.
Well, that’s not possible, so when is the next best time to plant a tree? Today.
Granted, if you need to start harvesting fruit from that tree immediately, that changes the equation some.
Great way to think about it.
Did I read that correctly? You took a mortgage on your paid off home and put the majority of it in the market? I was thinking of doing the same thing years ago. I feel as if my money is tied up in the bricks and mortar, I could do better long term in the market. Could you expound on what made you do this. Thank you.
Yessir – my logic is the same as yours. I’m paying 2.75% on the loan and getting better than that in the market.
Additionally – if I want/need cash for short term endeavors, I can sell these recent shares with limited realized income.
It does have cash flow implications. See this: Rent vs Imputed Rent.
I’ll expand on this in a future post, it’s on my list.
I know hindsight is 20/20, but I wish I would’ve done this years ago when I thought of it. I know there are risks, but I believe LONG TERM, VTSAX trends up and to the right. As long as you have the cash flow it sounds like an alternative. Albeit, not one the bogle heads would promote lol. I did something similar with a car loan I had at a .49% rate. I took the extra payments I could’ve made on the note, and invested that money in the S&P 500. Now, the car is paid off and I have 25K in that fund.
I look forward to that post Jeremy !! Thank you.
We cashout refi’d this year and added 25% of the house’s worth to our VTI holdings. A lower rate equal essentially the same monthly payment plus an additional six figures in the brokerage account – blows my mind.
Oh yeah – lump sum! It an instance were the math and the psychology (at least for me) go together. In the checking account it feels like hot potato – invest or get a….
This totally makes logical sense and I’m kind of upset at myself that, off the top of my head, I would have just assumed DCA was the way to go because diving in with a giant lump sum seems scarier. You’re right though.
Good examples and reminders from the article … and commentors…. it is good to revisit this topic for new and old readers’ education … I just sold a place in Asia … and may try your trick…here near lake Huron near the beaches… here can get a place like yours for 3 to 6 hundred thousand CAD … some good cross country skiing/skating etc … in the winter and camping , hiking, bicycling, gardening, swimming and boating in the summer fall and springtime etc …. did you take out a 5 year fixed mortgage rate ….? for 80% of the price…or something like that….did you play it safe with an S&P index fund or something different…. ?
oops should read 3 to 6 hundred g’s usd … I converted the price from CAD….. houses I find are nice but eat a lot of time … depends what stage one is at in life to see if it is a right fit ….
My backtesting shows cash is best on a risk adjusted basis – esp shortly after the central bank impounds the punchbowl:
https://imgur.com/1Jr2j1M
Seems that others select the worst cash investments to compare – not the best available at the time as I have.
This question is similar to “should I pay off my mortgage”
There is the mathematical question and there is the how will this affect my sleep question.
I tend to defer to the latter when considering these types of things.
Sleep is good – everyone who has a paid off mortgage because they like how that feels is doing the right thing.