Lump-Sum vs Regular Investing

How to invest a large amount of money wisely

There has been a lot of research done over the years about the comparisons of lump-sum investing versus dripping money into the markets. Most of the research shows that if you have a lump sum, then investing it all in one go and benefiting from more ‘time in the market’, usually trumps the attempts to drip it in over a longer time. (One example here from a recent Vanguard study.)

However, whilst the theory is nice to know, the reality is that for most of us, money is an emotional subject. It can generate powerful feelings and in spite of our best intentions, we are not always rational. We are likely to follow our hearts rather than our heads much of the time, especially when we experience higher than normal levels of stress.

What to do with $100k

Imagine that you had inherited $100k and put it all into the stock market, you then saw the market fall 50% over the next month. Headlines would be proclaiming the next financial Armageddon and ignoring the news would be impossible. Now imagine that money was your inheritance from your parents or grandparents. You would feel a sense of responsibility to steward the money well; you wouldn’t want to lose it. 

Of course, you haven’t really lost anything. It’s just the value of your investments has fallen, also known as a ‘paper loss’. You only lose money if you sell at a loss, but there will be conflicting emotions inside you. On the one hand, looking to seek and prevent further losses and on the other, the knowledge that if you leave it well alone, over time you should still come out on top. For these reasons, when I’ve had a lump sum to invest, I’ve compromised.

I’ve broken it down into a few large chunks and invested them over the space of a few months. Whilst it may not be the most efficient way to invest, it is a way of balancing my emotions and my human nature with my knowledge of investment performance.

I have also diversified my investments (see them here) in what is hopefully a wise way between asset classes. This reduces the risk of volatility within the portfolio of investments, reducing the chance of ever experiencing that 50% drop in value. It also increases the chance of earning a good return whatever the economic climate ahead.

But what about regular investing? When we don’t have those one-off windfalls. What’s the best way to approach that?

Regular investing pros and cons 

Regular investing is a bit like regular exercise – most of us rarely want to do it. There’s always something better to be doing, or in the case of investing, something else you could spend that money on, but it’s an important discipline and an essential part of your investing toolkit.

For most of us, savings from our income is what will make up the majority of our long-term wealth. Building a habit of saving a fixed amount every month (plus a portion of any bonuses or other variable pay you receive) is a way to force yourself to set aside a portion of your income for your future. This is all the more important if your employer doesn’t provide a pension plan, above the statutory end of service benefit. If no one else is going to help you build wealth, you will have to do it yourself.

If no one else is going to help you build wealth, you will have to do it yourself.

The best time to do this is as soon as you get paid. By taking a portion of your salary before you’ve had a chance to spend it on something else, you are ‘paying yourself first’, and guaranteeing that you hit your savings rate. You will quickly learn to live on what is left, and before long, you won’t even miss it. Much like regular exercise, it gets easier with time, and you may even come to enjoy the process, knowing that you are building long-term wealth for your future.

Cost Averaging

If you are able to invest regularly, dollar/pound/euro cost averaging is one of the most powerful tools you can use. By adding set amounts to the market on a regular basis, you gain a 2-fold benefit. You are forcing yourself to buy more when the markets are low (and inherently better value) and less when they are high. And if you have multiple assets that you invest in, (several ETFs for instance) and a target allocation, then regularly purchasing and rebalancing back to the targets also forces you to buy more of the worst-performing asset, further improving your chances of outperformance in the long run. 

Cost-averaging is a psychological tool too. Learning to buy more when markets have dropped and less when they rise takes a few mental gymnastics. I listen to the radio and regularly hear commentators report a “good day in the markets” when share prices have risen. But in reality, share price rises are only beneficial for investors if they are looking to sell.

For those of us purchasing and building wealth, we should be happy to see the things we want to buy at a discount, much like a sale at a shop. To enjoy price drops, or at least be immune to them, is an important mental discipline that can be trained by forced, regular investing.

In reality, share price rises are only beneficial for investors if they are looking to sell.

Exchange rate variations

One final thing that as expats we have to contend with is exchange rate fluctuations. There’s not much we can do about them, as the currency we are earning in and the one we want to save and invest in are usually fixed, but again by regular saving and transferring, we will hopefully benefit from rates averaging out over time. 

The downsides of regular investing

One possible downside of regular investing is that there is a small cost associated with it. Every time you make a transfer, exchange or purchase there are usually costs to bear. Although exchange fees have been dropping very fast recently, you still will struggle to avoid paying overseas transfer fees. Commissions on asset purchases can be very low using discount online brokers, but still a $10 commission on a $1000 purchase is a 1% cost, which is significant.

A sensible compromise for most people with moderate amounts to save would be to build up a larger cash amount over a few months, then make a transfer and investment purchase in order to keep fixed costs down. Quarterly perhaps, setting a reminder in your calendar or even automating it completely if you can. 

Some brokers allow you to make set, regular investments for a minimal trading commission. Some also facilitate low-cost dividend reinvestment. This is an excellent solution if you are able to access it, but in the offshore space many of us use to invest, it is unfortunately rare.

Summary

If you are able to build a habit of, or even automate the process of regular saving, exchanging and investing, you have a very powerful tool at your disposal. It is one of the few ways of mastering your emotions and the markets.

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