In this segment from the Rule Breaker Investing podcast, David Gardner dips into the mailbag and unearths this basic question: Is it better to take a large amount of cash you've recently acquired and get it all in the market right away or spread the investments out to reduce your risk? The answer has as much to do with psychology as it does with investing.
A full transcript follows the video.
This video was recorded on Aug. 30, 2017.
David Gardner: Mailbag Item No. 8 is the last of our investing classics. This one comes in short form from Simon. Simon said, "I love Rule Breakers and since signing up I've made some impressive returns on my investments. I do have a question though. When investing a lump sum Foolishly, is it better to invest an amount each month or over maybe 12+ months, or just go all in, straightaway, on a selection of stocks. Would appreciate your thoughts. [Simon Spear], London, UK." Thank you Simon for writing in.
So on the one hand you can imagine I might answer this in the way I just answered the previous question, which is be incremental. So with a lump sum for a lot of us in our psychology, it's stressful to think that all of a sudden you'd plunk all of that, that lump sum, into the market.
After all, you might be the unlucky person, I've felt this way in the past, who just bought right at the top. Right when you put in your lump sum the market sells off this autumn. And you're like why did I do that then? And why can't I be a better person or investor? Why does this always happen to me? I've felt that way, too, before.
That's why it's a lot easier for our psychologies often to say, "Lump sum. I'm going to break it up into," we'll just make this up, "five pieces and I'm going to invest one piece every two months. So on the first of the month on months one, three, five, seven, and nine, I'm going to invest one-fifth of that and I'm going to get invested over time." That way when the market goes up or down, you don't really care that much. You pat yourself on the back that you didn't put it all in at once and it feels easy and good.
And for a lot of people this is what actually gets them off their duff and invested. And I know this feeling, as well. I can empathize with all these feelings. Many of us use that lump sum as an albatross around our neck, dragging us down into this big, heavy thing and we don't get invested for quite a long time because we're too intimidated and stressed out by the prospect of investing that. And we often forego some good gains by doing that.
That's why I love the answer of the incremental. And yet that said, Simon, I would be remiss if I didn't quickly flip the coin over and describe the other side for you, because for some of us who don't need that psychological hedge, simple math will show that more often than not, simply investing a lump sum right away, all in, will perform better for you over time than those of us who took the incremental approach that I just described earlier.
And why is that? Well, again, it's simple math, isn't it, because when the stock market tends to rise, again, on average, 10% a year, and two years out of every three when the stock market... And I realize not a lot of people feel this way. They think it's a parabola but it's a hyperbola.
If you look at a chart of the Dow Jones Industrials over the last hundred years, or almost any stock market over the last X decades, you're going to see it goes up; therefore, every dollar you wait to invest -- if you invest in thirds, if you invest in fifths, if you're waiting with a portion of your capital -- chances are, all in all, that that money is sitting there doing nothing when it could have been rising a little bit.
So I hope I've done a good job showing both sides of the coin and I hope, whoever you are Simon, whether you're more that person who likes the incremental approach and you feel stressed by a lump sum, if that helps you, great. Or, if you're somebody who can flip the coin over and say to yourself, "I realize over the next three months the bottom could drop out of the market and you could lose 25% of its value, but darn it I'm still going to be invested and I'm just going to say that was bad luck. I can take it." If you're that kind of a person, then more often than not you'll be benefited by simply investing as much as you can as early as you can and hold it.