Anyone lucky enough to have a substantial amount of money to put to work in the market — perhaps as a result of an inheritance — is faced with a question. Is it better to invest all this cash in one go or smaller amounts at regular intervals?
I suspect the answer to this, at least according to research, might surprise you.
To lump or to drip?
Investing all your money in the stock market in one fell swoop does, of course, ensure that it goes to the very place that’s proven to outperform all other asset classes over the very long term. The quicker you put it to work, the more you’re likely to benefit from the magic that is compounding.
Given that cash payouts have been found to make up the majority of eventual returns (assuming they’re reinvested back into the market rather than spent), investing ‘immediately’ also allows you to receive dividends from companies whose shares you own.
On the downside, lump-sum investing feels decidedly risky. After all, you could be buying at the very moment markets are peaking.
Drip-feed investing (or ‘pound-cost averaging’) neatly avoids this. By regularly investing the same amount every month, you’ll buy some stock when prices are high and some when prices are low, thus smoothing out your returns over time.
A drawback of this approach, of course, is that no one knows where markets are going next. So, while drip-feeding works wonders in a falling market, the opposite will leave you with far less stock than if you’d gone ‘all-in’ from the off.
Another potential issue to the drip-feed approach is that it can be hard to decide exactly how much you should invest every month when you’re working with a lump sum. To complicate matters, the longer this money stays in your cash account, the more likely its value will be eroded by inflation.
What does the evidence say?
It might surprise you to learn that according to a study conducted by US passive investing powerhouse Vanguard back in 2016, lump-sum investing generates better returns than its drip-feed counterpart roughly two-thirds of the time.
This was true regardless of asset allocation (e.g. whether you had all your money in equities, all in bonds or a 50/50 split) and whether your money was invested in the US, UK or Australian markets. Nevertheless, the average outperformance of lump-sum investing wasn’t that big (2.39% in the US, 2.03% in the UK and 1.45% in Australia).
So, I should just invest it all?
Not necessarily. While Vanguard’s research suggests that lump-sum investing generates slightly superior returns more often, this doesn’t automatically make doing it any easier, particularly at times when markets are looking expensive (such as the US right now).
If investing everything at all once will keep you awake at night then the potential for slightly lower returns through the drip-feed approach might be a price worth paying. You may even get lucky and see markets fall over the time you’re investing.
That said, Vanguard does recommend moving money into the market over no more than one year so that you aren’t in cash for too long. If you fear a crash, this could involve increasing your allocation of less volatile assets such as bonds and moving into equities at a later date.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.