What caught my eye this week.
I am running late this week, so I’ll cut straight to the chase and suggest you check out this post on investing a lump sum over at the Of Dollars and Data blog.
Author Nick Maggiulli writes:
The main reason Lump Sum outperforms Dollar Cost Averaging [DCA] is because most markets generally rise over time.
Because of this positive long-term trend, DCA typically buys at higher average prices than Lump Sum.
Additionally, in those rare instances where DCA does outperforms Lump Sum (i.e. in falling markets), it is difficult to stick to DCA.
So the times where DCA has the largest advantage are also the times where it can be the hardest for investors to stick to their plan.
Nick made his bones with animated graphics, but he hasn’t done so many of late.
This post is full of them! The example below shows how the underperformance of dollar-cost averaging increases as the length of the buying period increases.
Our view is that deciding whether to invest a lump sum or put the money in over time is – and should be – an emotional decision, not an intellectual one.
Are you freaked out by the very idea of putting a life-changing amount of money into the market in one go?
Then don’t do it. But do make sure you have a strategy to get the money invested sooner rather than later.
As Nick vividly illustrates, most of the time you’ll pay a high price for leaving cash on the sidelines.
Important note: A long-time reader reports being cold called by an ‘adviser’ claiming to have gotten their telephone number from Monevator. I know nothing about these people and any such calls are not anything to do with this site. Please be careful! My personal rule is NEVER EVER to invest a penny as a result of a cold call. Ever. Unfortunately, people trading off the reputation of others is a growing problem, as Martin Lewis recently went to court to prove.
From Monevator
How did Warren Buffett get rich? – Monevator
From the archive-ator: They don’t tax free time – Monevator
News
Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!1
What price pension freedoms? [Search result] – FT
[Surprisingly] Madoff trustee has recovered 76% of $17.5bn swindled – Reuters
Global dividends hit new record [Search result] – FT
First-time buyer numbers reached a 12-year high in 2018 – Property Reporter
London’s property flippers forced to sell at a loss [Search result] – FT
Africa is a real demographic outlier – Visual Capitalist
Products and services
Royal Mail to donate £60,000 to charity after breaking stamp price rise cap – Guardian
Households spend 10x more toasting bread than charging phones – ThisIsMoney
RateSetter will pay you £100 (and me a bonus) if you invest £1,000 for a year via my affiliate link – RateSetter
[Selective?] data shows rare winning fund returns fall when stars leave – ThisIsMoney
Seeing green: The Foresight UK Infrastructure fund – DIY Investor UK
Beware of a sim card swap scam that can empty your bank account – ThisIsMoney
Homes for sale that come with a perk [Gallery] – Guardian
Comment and opinion
Why do markets go up? – Factor Investor
Fast cars, low returns – Scalable Capital
The case for investing in international bonds – Young FI Guy
Time for Gen X to rally – Money Maven
You wouldn’t wish typical hedge fund returns on anyone – Evidence-based Investor
No-one wants to invest in your shit – Meb Faber
Rental DIY Step 1: Find a tenant – 3652 Days
Rich People’s Problems: I have bonus envy [Search result] – FT
If you love your spouse, FIRE them [Um…] – Financial Samurai
Warren Buffett’s brother from another mother – Abnormal Returns
My financial mistakes – Mrs Young FI Guy
First-mover alpha – A Wealth of Common Sense
What infrastructure has to do with investing – Oddball Stocks
Is HSBC worthy of investment, 10 years after the crisis? – UK Value Investor
Brexit
Holidays 50% cheaper the week after Brexit, due to uncertainty – ThisIsMoney
Three Tory ministers set to rebel to stop no-deal Brexit [Search result] – FT
What is the practical impact the next day if there’s no-deal? – Guardian
As Britain self-combusts, Ireland is seizing the opportunity – Fortune
Marina Hyde: The country needs Tom Hanks. We get Derek Hatton – Guardian
Kindle book bargains
Antifragile: Things That Gain From Disorder by Nassim Nicholas Taleb – £1.99 on Kindle
ReWork: Change the Way You Work Forever by Jason Fried – £1.99 on Kindle
Unscripted: Life, Liberty, and the Pursuit of Entrepreneurship by MJ DeMarco – £0.99 on Kindle
Off our beat
How it feels to win a lifetime’s supply [Of books, milk, KFC…] – Guardian
There’s only one thing to do with today: Seize it – Ryan Holiday
Tim Ferriss interviews Jim Collins [Podcast] – Tim Ferriss
How to build Atomic Habits – Rad Reads
Different kinds of stupid – Morgan Housel
Boy, 12, creates nuclear reaction at home [Note to self: Must try harder] – Guardian
And finally…
“You do not rise to the level of your goals. You fall to the level of your systems.”
– James Clear, Atomic Habits
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Re The Royal Mail.
Can someone explain why they’re allowed to breach their price cap, if they give it to charity?
I hope the regulator has more to say about this.
For some reason I can’t read the ft links even in incognito mode. What am I doing wrong
Scratch that only seems to be the first one weirdly
Good article. Read through it waiting for the rebuke (I am reluctantly investing pension lump sum) but was very surprised and relieved by the recognition it’s an emotional issue. Hadn’t realised that in myself but yes indeed it is, so thanks.
The other highlight is in the Financial Samurai link. Who would have guessed that ‘weight gain’ was explicitly in the top 10 reasons for divorce. I wonder how that plays out…….
So, where or how do I get this lump sum?
Dca makes sense because most people receive money on a monthly (or weekly) basis and regular saving is a discipline that should be encouraged.
If or when people receive a lump sum (inheritance, PPI, lottery, redundancy) the question is not should i invest in one lump or over 12 / 24 / 36 / 60 / 120 months but what should I buy for myself. That’s human nature.
The Foresight Intrastructure OIEC is an interesting find by TEBI. But as ever with such funds-of-funds the problem is cost. Not only do you have the high charges of the underlying investment trusts but also Foresight’s OCF of 0.65%, plus their transaction costs. The fund is new enough not to have published any accounts so you can’t say what all this amounts to, but I’d hazard a guess you’d be paying a good 3.5 % all in. That said, a good 5% of my portfolio has for some time been in infrastructure ITs. Expensive they are, but to my mind the unlisted assets they invest in are a good (often index-linked) diversifier that provide decent income. I think of them as adjuncts to my commercial property ETFs. Providing you’re OK with the political risk (the generalist ITs are very PFI dependent, the renewables government subsidy and feed-in tariff dependent) then to my mind they’re worth a close look. I’d be interested to hear what others think.
There could be opportunity cost in raising the lump sum itself, depends if your lump sum was:
– Cash you saved up first
– An inheritance that was built up from cash/property before you had it
– An inheritance that was mostly equities beforehand (as if!)
– Because you have irregular income (popstar? Property flipper?)
– A loan (market timing in my book)
So £/$CA is probably the quickest way for normal wage earners to put in
And an inheritance could overload your tax wrappers, suddenly I would have to do tax returns? (shudder) which I never bothered to learn about before
£/$CA ought to be better for drawdown… The thought of having to sell one day does unnerve me as it’s one point where timing does matter, and it would’t just bounce back if by some fluke it’d crash at that moment!
Interesting but as a real life example can I offer myself? I transferred a dB pension to a SIPP. £200+k. I have another £250k in a DC scheme. Owing to the ability to take 25% tax free you can understand the desire to have 25% as cash and be conservative as you approach decision day. I will only get to do this once and the financial position of my widow in 30 years time might hinge on it. Not straightforward.
RE weight gain …
Well if you gained 20% weight since your wedding day, that’s 20% of you that your spouse is not married to. So to get rid of the 20% by divorce the rest unfortunately has to go with it.
@The Investor. I agree that there is a strong emotional element to the PCA / lump-sum debate. It is essentially the loss aversion described by the founders of behavioural economics, Tervsky and Khaneman. But there is also a rational justification for those of us near to retirement. i.e. We don’t just mind losses more but losses actually matter more as we have less time and less future earnings to make any losses good. Essentially an investor might take the view that by drip feeding into the market over 12-18 months likely gains will be less but the risk of a serious loss (say by investing just before a 25% draw-down) is also significantly less. On this analysis pound cost averaging is basically an insurance policy – foregone potential gains being the premium for less chance of serious loss.
I previously saw a now old article by William Bernstein on his Efficient Frontier dormant website indicating that the ‘sweet spot’ for drip feeding is between 12 and 18 months.
Ok, as someone unexpectedly acquired a life changing lump sum via inheritance, I can tell you it took me THREE YEARS to become fully invested. The first year was full of experiments (aka mistakes) and rather strange investments, luckily I couldn’t bring myself to invest more than about a thousand pounds in one go. It took about two years to develop a portfolio and approach I was happy with, and gradually ramp up the amount I invested each month. Automating helped a lot.
I’ve just tried and I can’t replicate his numbers. I took a portfolio, split 60% S&P total return index, 40% US Treasury total return bond index, and residual cash in a T-bill total return index. After 12 months, I get the outperformance at more like 1.5% (vs. his 4.3%) and after 60m at 7.0% (vs. his 17.5%). Is he accounting for the returns on cash? If I switch to a LIBID index in the 90s, the return difference narrows more. He’s also using the 5-year Treasury, rather than just using a full index.
I agree with TI this is an emotional decision, but even intellectually it feels a little simlpistic to go all-in. Yet again, it assumes that the only criteria for success is maximizing wealth in the average scenario. The problem is I don’t live in the average scenario. Surely what matters here is the whether you have a shortfall or excess vs. your liability target. Looking at my data, you typically get an excess with a less frequent, but quite nasty, shortfalls. In those shortfall situations you’re stuffed!
I have purposely not been investing automatically on a monthly basis to reduce costs (trading fees were eating into what I could invest). I had intended on manually contributing every three or four months but laziness + life meant this never happened. I now have the best part of a year of savings-for-investment to use.
What is stopping me right now is brexit… I’m genuinely not trying to time the market, but I keep hoping for some certainty of a no-deal / something positive such that the market reacts and I know what I am buying (sort-of like overtaking a lorry not to beat it in a race but so you can see / prepare for the road ahead). This feels like a similarly emotional choice as PCA vs Lump, but would be happy if someone could give me a reason why I am just bonkers and should go all in now.
I’m with TI, Passive Investor and ZX on this one. It doesn’t seem right to compare dollar cost averaging and lump sum investing based on returns alone. That clearly ignores the very important financial protection aspect to cost averaging. As Passive Investor points out, it is in effect an insurance policy against nasty market shocks.
As the Vanguard paper referred to states:
“Even though LSI’s [lump sum investing] average outperformance and risk-adjusted returns have been greater than those of DCA, risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline. These concerns are not unreasonable. We found that DCA performed better during market downturns, so DCA may be a logical alternative for investors who prefer some short-term downside protection.”
p.s. thanks for the crunching the numbers ZX. From having just looked at Nick’s tweets, he appears to have not included the return on cash in the lump sum scenario which significantly reduces the ‘outperformance’ as you have calculated. Great spot!
@ Steve I don’t think you are bonkers! Whether you go all in now depends partly on your age, how quickly you need the money and what the sum is relative to your income and wealth. Brexit is unsettling as it’s impossible to tell what will happen and what the effect of whatever happens will be on the markets. (A WTO Brexit might result in a lower pound and therefore a rise in non UK equities or then again it might not.). Then perhaps there will be a Corbyn government…
I really hate the idea of investing before a market fall even though in 10 years time any downturn will probably look like a blip on the rising graph. For it’s worth what I generally do is invest 25%-30% straight away and the remainder over 10 – 12 months. There’s no science in this and I am probably poorer for the strategy over the years but it suits my psychology and allows me to sleep at night.
@ Steve. I have an ongoing DC pension that is 60% in cash having derisked a few years ago prematurely as it turned out. Thing is at some stage soon I will transfer to a SIPP. Then, if equities have fallen, fine. If they have gone up then I will have to buy at the higher price or stick with cash. If I invest more in equities now then even if they fall I will be able to switch at the lower price. Ditto bonds. In other words I should try to match the target investment profile irrespective of the imminence of ‘cashing out’ event. Not in a hurry to do it though! My biggest concern is actually bonds: if we have an equity market decline and recession I might have to buy at even lower yields than now. This I have been prempting as best I can by hedged short duration ETFs/ funds. There are risks in staying in cash. So my approach given my age is 30% equities, 30% bonds and 30% cash for now…time will tell is this is smart. Need to stick your toe in the water though.
Large lump sums to invest are more common than you think, with redundancy, transfers between ISAs and pension schemes etc, as they always seem easier done in cash.
I work on investing 1/3 at a time, a month apart, as that balances the head-smacking of a sudden fall (Guess who invested the week before the 1987 crash) and being out of the market.