How to invest: Should I invest as a lump sum or gradually?
If you look for a common thread in all the articles we write, one of the comments you will see repeatedly is this truism about investment markets: markets go up over time, but not in a straight line. Sometimes we state it differently, that markets will go up and down from one day to the next but in the long run they can be expected to increase.
You can see this in the graph below from the JP Morgan Guide to the Markets. When markets are rising it is called a bull market and when markets are falling it is called a bear market.
This graph shows that bull markets are longer and stronger than bear markets. Put simply markets spend more time going up than they do going down. Evidence of this can be seen in a long term graph of stock market prices. Below is a graph of world stock prices for the last 50 years. Despite periods of downturn the markets have continued in an upward direction.
This brings us to the question of whether one should invest a lump sum in one go or gradually in smaller amounts over time.
If you have the choice and the opportunity to invest as a lump sum, in most cases it makes sense to do so.
Why?
For several reasons.
Because based on the information above, markets tend to go up and the longer you are in the market, the greater will be the increase in your investment’s value. To consider the graduated market entry, the average price of entering the market will likely be higher.
If markets spend more time going up than going down, as we have shown above, it is less likely you will have timed that opportunity to capture cheaper prices. There are exceptions to this of course, however we are firm believers that it is difficult, if not impossible, to time the market.
The cost of waiting by making gradual additions to an investment is the opportunity cost of being invested and reinforces the perils of trying to time a market. The other factor is the psychology of investing. If you did manage to time it right, it would mean each subsequent month you added to your investment, the value qill have fallen from the previous month. This means that all investments you have made to that point are negative. In a long term focused investment that is normal, this happens, but it often dissuades investors from sticking to their schedule. Investors are more likely to stop the regular investment when markets are falling, even though that is the short term market scenario they need for the approach to work.
Here is an example: All figures are hypothetical but reflect patterns of market movement that have happened repeatedly over the last 25 years. An investor decides they will wait for the next downturn before investing. While they are waiting and getting next to zero return in cash, the market rises 15%. Then it does correct and drops 6%. The investor decides this is the opportunity to invest. By the time they have acted, and transferred funds, the market may have recovered one third of this drop, or 2%. Putting actual numbers on this, they avoided investing at a price of 100. The market went to 115. Then it dropped to 108.1. After that it recovered to 110.26 when they actually invested. This means they are more than 10% worse off having waited.
The above represents a simplification of market dynamics and there are several factors an investor should consider when deciding to invest. There are times in the market when it is prudent to be cautious or gradual, but it generally for other reasons, and not to try and time a market.
The best investment you can make is to get the advice of a professional. Speak with us at Black Swan Capital and we can help you to weigh up all the variables such as your risk tolerance, your goals and objectives, your time frame, impacting factors such as where you live and the passports you hold, and then, an informed decision can be made as to where and how you can invest. The result, peace of mind and an alignment between what you are trying to achieve, and the actions you take.
Contact us at info@blackswancapital.eu.
