An episode from Vanguard’s Investment Commentary podcast series

For more on how to think about investing a lump sum, read Invest now or temporarily hold your cash?


All investing is subject to risk, including the possible loss of the money you invest.

Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling.



Mike Custer: Hello, and welcome to Vanguard’s Investment Commentary Podcast series. I’m Mike Custer. In this month’s episode, which we’re recording on November 21, 2016, we’ll talk about our latest Financial Planning Perspectives piece, Invest now or temporarily hold your cash? This paper focuses on whether investors should invest lump sums immediately or systematically over time. We’re joined by Daniel Berkowitz, an investment analyst in Vanguard Investment Strategy Group. Thanks for being here, Daniel. Daniel Berkowitz: Sure, great to be here. Mike Custer: So let’s start off with, Why is this an important topic for investors? Daniel Berkowitz: So, many investors will come into a lump sum of cash of some varying size over the course of their lifetimes—you know, whether that be a pension payment or an inheritance or even proceeds from the sale of a small business. And this is important, because it’s challenging to figure out how to invest a large sum of cash when those stakes are really high. And we as investors, we want to avoid any potential mistakes that might hurt our odds of long-term investment success. Mike Custer: There are a lot of terms surrounding this that are going to pop up in our conversation. Why don’t we define a few of those, starting with systematic investing. Daniel Berkowitz: Sure. So I will refer to the gradual investment of a lump sum as a systematic implementation or a systematic investment plan—that being splitting a large sum of money up into smaller increments and investing it through time. We typically hear the term dollar-cost averaging used to describe this type of systematic or gradual investment, and many people are familiar with that term. Mike Custer: But I think in this research, it’s used a little bit differently. Could you go into that for us? Daniel Berkowitz: Yeah, we see the term dollar-cost averaging used frequently in the financial press. Dollar-cost averaging, though, it’s also used to describe making fixed dollar investments through time and with current income as it becomes available. And that’s a slightly different situation from the one that we’re describing here today, where that lump sum of money is immediately available to be put into the markets. Mike Custer: Great, thanks for the clarification. So when it comes to investing large sums of cash, history and theory support investing it immediately over investing it systematically. And why is that? Daniel Berkowitz: The answer is actually fairly intuitive when we break it down. By putting money to work immediately, investors are exposing their cash to financial markets for a longer period of time. And we know that stocks and bonds are expected to provide a positive return over cash for those risks that investors take by holding them. On the other hand, for those that do choose to invest systematically or gradually, a piece of that cash balance sits on the sidelines for a longer period of time, and it’s uninvested. And so, on average, it would make sense that investing a lump sum immediately is going to outperform a systematic investment. And that’s exactly what we found in our research. Mike Custer: What did your research find regarding the frequency of outperformance of investing immediately compared to investing it systematically? Daniel Berkowitz: When we looked across global markets, we found that investing immediately outperformed systematic plans roughly two-thirds of the time, or about 68% to 70% of the time, depending on the market that you’re in. Mike Custer: Could you go into a little bit of the methodology of how you guys came up with those numbers? Daniel Berkowitz: Yeah, sure. So we used a local investment in the United States, United Kingdom, and Australia—so three different markets—to test whether those results would be consistent around the globe. Our lump-sum portfolio was an immediate investment in a 60/40 portfolio of local stocks and bonds, and we held that for 12 months. Our systematic portfolio used that same 60/40 mix, but instead, we split the lump sum into 12 equal installments, and we invested those installments on a monthly basis. And at the end of each 12-month period, the portfolios would have identical asset allocations. And then we compared them to measure how frequently our immediate portfolios outperformed our systematic portfolios over these long sets of rolling annual periods—so, big, historical time periods. And again, we found that the immediately invested portfolios, they outperformed about two-thirds of the time or about 66% of the time in each of the global markets. Mike Custer: And by how much? What was the magnitude of outperformance in these scenarios? Daniel Berkowitz: Yeah, it’s a great question because we want to know by how much too, right? And so we found that the immediately invested portfolios outperformed by about 1½ to 2½ percentage points, on average, depending on the market. And let me just make sure that I note the probabilities and the magnitudes that I mentioned to you—that two-thirds of outperformance, that 1½ to 2½ percentage points—they should be viewed as a reference point. They’re based on historical numbers, and it’s certainly possible for either an immediate or a systematic investment plan to outperform in any one given period. Mike Custer: It’s a great point. So the research paper focused mainly on 60/40 portfolios. Would the story be different if we looked at portfolios with markedly different asset allocations? Daniel Berkowitz: We did tilt our portfolios’ asset allocations to make sure the results held up for other splits between stocks and bonds. And we found that they did. We looked at portfolios of 100% stocks, 50/50 stocks/bonds, and 100% bonds. So the full continuum. And that two-thirds frequency of outperformance, it held fairly consistently. And most of the changes were marginal, about plus or minus 5 percentage points to those probabilities of outperformance for the immediate plans. We did also examine whether longer investment intervals would affect the results as well, and we found they only strengthened our conclusions. Mike Custer: Oh yeah. Why don’t you tell us more about the time. Did you look at a certain period beyond one year? Daniel Berkowitz: Yeah, so the investment interval being the length of time that the systematic investment occurred over. And generally speaking, the longer the systematic plan window—so for example, investment over the 36-month period instead of 12 months, as you mentioned—that generally increased the frequency of outperformance of our immediate investment plans. Mike Custer: Okay, so history and theory and your research are supporting the immediate investment. But could you describe a situation when a systematic investment plan would be helpful for an investor? Daniel Berkowitz: Yeah, absolutely. So we think that most investors who choose to invest systematically are actually more concerned about worst-case scenarios in the markets rather than those averages or probabilities that we just talked about. And as an investor, it’s easy to think to yourself, What happens if I invest this large sum of cash that I recently came into, and the markets plummet, and I’ll just watch my portfolio dip in value? Investing is an emotional process; we know that. And investors may feel they’re protecting their assets by easing into the market through gradually investing. That’s not an unreasonable thought. Mike Custer: Right, so this is almost emotional or psychological support as much as it is an investment-planning step. Daniel Berkowitz: Yeah, it certainly is. Mike Custer: Now you mentioned, you know, the worst-case scenarios. Let’s say that the markets do dip. Has this kind of plan protected them against the downside risk? Daniel Berkowitz: Yeah—so systematic investment plans, they can provide some downside protection in poor market scenarios. To assess that level of protection, we split our portfolio returns into deciles, and we looked at the average return in each decile from both an immediate and a systematic strategy in our three geographic markets—so, again, the U.S., the United Kingdom, and Australia—to look for that consistency in the investment results. And in the worst decile of market performance, or the worst 10% of portfolio return scenarios—so the very bottom—we found that the systematically invested portfolios, they outperformed by 7% to 8%, on average. Mike Custer: Oh, why is that? Daniel Berkowitz: Well, the greater cash weight provided a buffer for the systematically invested portfolios—and that makes sense. But in the vast majority of market scenarios, as I mentioned to you earlier, the immediately invested portfolios did still outperform. So for investors looking for some downside protection, using these types of systematic implementation plans can be reasonable, provided that investors understand they may be giving up some return to do so. Mike Custer: So barring, you know, the worst-case scenario in the markets, are there actually other scenarios where a systematic investment plan would still be helpful to an investor? Daniel Berkowitz: Yeah. The other time a systematic investment plan may make sense for investors relates more to investing discipline. And I’ll talk about discipline in two different ways. The first is for investors who are just hesitant to make that initial investment. We call this “the paralyzing fear of regret” in our research. A systematic investment plan, it can be great in helping investors overcome that initial fear of loss and prevent further delays to making that initial investment—just to get the cash into the markets. A second time a systematic plan might make sense regarding discipline is to help investors stay the course. And what I mean here is to not abandon an asset allocation during rough market patches. Mike Custer: And what could happen if that were the case, if someone were to deviate from their initial plan? Daniel Berkowitz: So what can happen is, investors may, for example, invest a lump sum immediately, and should a market drop occur, they naturally want to move back into cash or to a safer asset allocation just because of the sheer amount of money that’s at stake. So for some investors, setting up a systematic plan may make it more likely that they’ll stay the course and they’ll remain invested in their target allocation by finishing that systematic investment program and seeing it all the way through. And this is ultimately what’s important in the long run. Mike Custer: Yeah, this idea of a tentative investor, one who’s emotionally skittish and wants to pull their money out once the markets turn, seems like something advisors might be interested in. Do you have any thoughts on that? Daniel Berkowitz: Yeah, I certainly do. And so let me stress again, though, that using these types of systematic plans—it has given up some return, on average, but there are certainly situations where investors may be better off using this type of strategy. And this is really where advisors can add a lot of value. In helping investors either design a systematic plan or make that initial investment—this is behavioral coaching at its core. And because discipline investing really is not easy, this is a powerful way advisors can help investors stay on that path to long-term investment success. Mike Custer: Great. So if an investor does decide to invest their cash systematically, how should they do it? Daniel Berkowitz: We recommend two things. First, make sure the investing is actually done systematically, and second, keep the time frame for the investment to under one year. Investing systematically means being disciplined with making regular investments over some particular frequency, like each quarter or every month. We chose to use monthly as a default in our research, but that’s certainly not the only way to do this. And keeping the time frame under one year—it helps ensure that the cash doesn’t stay uninvested for too long, so investors can benefit from those risk premia that come from holding stocks and bonds or that provide that long-term growth in assets. Mike Custer: Makes total sense. Are there any other words of advice you would have for investors who do find themselves in the situation investing systematically? Daniel Berkowitz:Yeah, I do have one final point I want to make. What we didn’t address in our conversation here today is broader questions that may be raised by a big cash inflow. A big change in an investor’s financial circumstances can alter investment goals, and it can actually also alter risk preferences too. For example, an inheritance may be enough to pay for a child’s education or fund retirement savings immediately—two common examples. And so I’ll end with noting that personal reflection or consultation with a financial advisor can provide more insight into some of these bigger questions that we didn’t have a chance to address here today. Mike Custer: These are great insights, Daniel, and I want to thank you, again, for being here. And thank you for listening to the Vanguard Investment Commentary Podcast. Be sure to check with us each month for insights on the markets and investing. You can always follow us on Twitter or visit our website at any time. Notes:
  • All investments are subject to risk, including the possible loss of the money you invest. The information presented in this podcast is intended for educational purposes only and does not take into consideration your personal circumstances or other factors that may be important in making investment decisions.
  • Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling. You should consider whether you would be willing to continue investing during a long downturn in the market, because dollar-cost averaging involves making continuous investments regardless of fluctuating price levels.
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