Newspaper article Sarasota Herald Tribune

Should You Invest Lump Sum with Logic?

Newspaper article Sarasota Herald Tribune

Should You Invest Lump Sum with Logic?

Article excerpt


Over our lifetimes, some of us will be fortunate enough to come into a substantial amount of cash in one lump sum. Supposing that the lucky one is not in the market for a new jet, the question is: What's the best way to invest it?

Such a windfall should be viewed as an integral part of an investor's portfolio, not as a standalone entity. It should be invested in line with the investor's existing asset allocation.

The timing of the investment raises a more complex question: Should it be invested all at once, or gradually?

The answer involves a conflict between statistics and the psychology of human behavior. The statistics tell us that all at once will likely provide a better return than gradually. But human behavior studies show that a loss of a given dollar amount is about 1.5 times as painful as a gain of the same amount. This means that many of us may be willing to forgo some likely gain if it means that we will be less likely to suffer a significant loss.

Let's look at what a variety of studies show about immediate investing versus dollar-cost averaging -- dividing the lump-sum in a number of equal parts and investing each one periodically. For example, dividing by 12 and investing each part once a month for one year.

One study looked at every 12-month period from 1926 through mid- 2014. A lump sum would have an average return of 9.57 percent (assuming a 60/40 stock/bond allocation). A three-, six- or 12- month DCA would have had average returns of 8.85, 7.61 and 5.17 percent, respectively. The difference between the 12-month DCA and the lump sum method is 4.58 percent, a significant difference.

The study also showed that the worst 12-month loss for the lump sum was 42 percent, versus 32 percent for the 12-month DCA. The best 12-month gain for the lump sum was 103 percent, versus 44 percent for 12-month DCA. …

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