At some point in your life you may receive a large sum of cash, such as a pension payout or inheritance.
Many investors nevertheless choose to put the money to work over time, a systematic implementation plan that is commonly referred to as dollar-cost averaging.
History and theory support immediate investment.
On average, an immediate lump-sum investment has outperformed systematic implementation strategies across global markets. This conclusion is consistent with finance theory, as immediate investment exposes cash to (historically) upward-trending markets for a greater period of time.
Immediate investment led to greater portfolio values approximately 68% of the time based on a 60/40 portfolio). On average, immediate investment outperformed systematic implementation by a high of 2.39%. These findings are unsurprising. Stocks and bonds have historically produced higher returns than cash, as compensation for their greater risks. By putting a lump-sum to work right away, investors have been able to take advantage of these risk premia for a slightly longer period.
The research by Vanguard also shows immediate and systematic plans over shorter and longer investment intervals using the same 60/40 portfolio. As the interval increased, the immediate investment outperformed more frequently. For example, immediate investment of a lump-sum outperformed a 6-month series of investments in approximately 64% of the historical periods. Over a 36-month interval, immediate investment outperformed approximately 92% of the time.
Having said this, a systematic implementation provides some protection against regret. Systematic investment of a large sum can be thought of as a risk-reduction strategy. Such an approach can moderate the impact of an immediate market dip. Historically, however, the trade-off has been a lower return in the majority of market scenarios.
So the question to ask yourself is: are you seeking to reduce your regret or are your seeking to maximize your return? Keep in mind, that finance theory and historical evidence suggest that the best way to invest this sum is all at once.
Paul R. Rossi, CFA