The following question is from Todd, who is in his early thirties and wonders how he should invest a lump sum amount:
I have a significant amount of money in an RRSP - $60K, but this is mostly in cash. Each pay cheque more money is being added (matched by employer). How would you go about putting this money to work? I’m hesitant to just put it all to work in a sleepy portfolio right now at what seems to be a point when the market has gone up already for years, should I average in over the next year? Or is the best thing to do is to invest it all right now? I’d be very interested in a blog post about how to boot up an investment plan when you have a fairly large amount saved in cash.
For now I’m changing the rules of the plan so that it invests new money into a sleepy portfolio. But what do I do with the existing cash?
Many studies have used historical data to figure out whether lump sum investing or dollar cost averaging would have made the most sense and concluded that, on average, you would have been better off investing immediately. The conclusion makes logical sense since markets go up more often than down and you pay an opportunity cost in looking for attractive entry points.
In investing though, emotions play a larger role than logic. You have the capacity to take risk - you have many decades to retirement and you have the staying power to recover from any temporary setbacks in a diversified portfolio. Still, investing a lump sum in the equities market makes sense only if you won’t panic and sell in a downturn in the equity markets. You may not even be able to estimate your risk tolerance correctly unless you have experienced stock market losses before. So, the answer really depends on what kind of investor you are. Ultimately, only you can answer that question.
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14 responses so far ↓
1 willfly // Oct 17, 2007 at 10:44 pm
The study showed that lump sum performed better then DCA 2/3 of time. This can easily be attributed to the fact that on average markets in the past have gone up more then down. I agree with Todd that markets have had a good run up until now. In my view there is a bleak probability that this massive bull market will go on well into future. If equity market does follow 16 year cycle as Warren Buffet mentions, then we are approaching the end.
Being in a similar position, I decided to take up DCA approach, investing equal amounts over 2-3 year period.
2 FourPillars // Oct 17, 2007 at 10:53 pm
It’s definitely up to Todd to decide but I would suggest that he doesn’t go overboard in trying to analyze this decision.
If he does a sleepy portfolio then he’ll have 80% in equities which is $48,000. While nothing to sneeze at, this amount will not seem so large in another 5-10 years when your rrsp will probably be double or triple your existing $60k.
Personally I would say just go ahead and invest it all now but if you want to take a few months and spread it out a bit then that will work fine as well.
Mike
3 Nabloid // Oct 18, 2007 at 12:44 am
Invest as you find suitable investments… if you find suitable investments for the entire amount right off the bat… go right ahead. But rather than invest it all in something you don’t like or understand, take a few moments and breathe, then start doing some research.
4 Phil S // Oct 18, 2007 at 7:13 am
For me personally, I’m expecting an economic recession in the USA very soon (maybe within the next year or so?). Although I’m not selling the equities that I currently hold, I’m not putting any “new” money to work until I see what the effects of a US recession has on Canada and indeed on the world. The USA has traditionally been the importer of all of the world’s goods, as almost every other country in the world is a net exporter of goods. As a result, in my opinion, a recession in the USA and the plummeting greenback will probably drag the entire world into recession. It’s like the old adage: “When the US economy sneezes, the rest of the world catches a cold.”
As a result, all my “new” money is getting socked away into cashable 1-yr GICs or Treasury Bills for now. As I mentioned, I’m not selling any of my current equities just in case I’m totally wrong and we all manage to escape an economic recession.
I have been debating with myself when to put some portion of my RSP money into euro bonds as a sort of currency play as I think the commodity based loonie is overvalued and will drop when commodity prices inevitably falls. But right now I find it difficult to find a fund with a reasonable MER that is invested primarily in Euro bonds (I don’t want any US bonds in the mix).
So, in summary, my opinion is that being in mostly cash and short term securities isn’t a bad place to be at the present time. You shouldn’t think that you have to be fully invested in the market to get the best returns. After all, earning 4% on a GIC or T-Bill sure beats the heck out of a -20% return if we dive head first into a recession.
5 Riscario Insider // Oct 18, 2007 at 9:34 am
As the post and comments above show, there’s no consensus on the “right” action.
This month’s issue of Money Advisor by Consumer Reports echoes the research saying that “you’ll generally do better investing all at once rather than in increments” but goes on to say that “averaging shines in times of crisis” and gives four examples: oil crisis (1973), Black Monday crash (1987), Sept 11, 2001 and Bear market of 2002. Were those statistical anomalies predictable?
As CC notes, we may find that we’re less tolerant of risk than we think when tested by a sharp drop in the market.
6 Canadian Capitalist // Oct 18, 2007 at 10:12 am
Thanks for your insightful comments. My personal opinion is that stocks are reasonably priced at roughly 18 times earnings. Not a great deal, but not too high either. As for the near future, who knows? I still think the credit crisis isn’t over yet but I could be totally wrong (won’t be the first time).
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8 WhereDoesAllMyMoneyGo.com // Oct 18, 2007 at 10:53 am
I’ll add my two cents - all the comments provide good food for thought IMO.
Consider that since 1957 the average bull market lasts 32 months and we are in month 62 of the current bull market (longest since then), and that the average bear market lasts 11 months - makes me a bit weary about “reversion to the mean”.
While I don’t believe you can time the markets, I do believe you can take advantage of opportunities when they present themselves.
IF you are interested in averaging out, or even waiting for opportunities one idea is the following:
With $60,000 you could setup a 10 year bond ladder. When no opportunities present themselves you could invest the coupon payments and annual maturity principle of a bond into the markets. If an opportunity presents itself you could sell some bonds as needed to take advantage. This way you are not locked in to anything and still getting some returns while allowing for flexibility.
I’m just shooting from the hip here.
Also consider that if your call on the economies here are negative, then interest rates will fall increasing the value of your bonds.
You could put the lump sums that accrue from the coupon payments and bond maturities into the worst performing component of the sleepy portfolio. I have to admit I haven’t really looked at it, and just assume it is a variant of the global couch potato portfolio (I know I’m bad - I’m going to go look at it right now) :
9 Canadian Capitalist // Oct 18, 2007 at 11:11 am
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10 ThickenMyWallet // Oct 18, 2007 at 11:55 am
These are all insightful comments. To me, the biggest factor is Todd’s age. He’s young. He has a lot of time for his RSP to grow. He should take an approach he is comfortable with and focus on the fact he has 30 years to grow his portfolio and not on short-term trends in making his decision.
11 Neil Galloway // Oct 18, 2007 at 2:05 pm
For me, I do both. Diversification of the investment techniques. It is always good to sock away every month, sometimes if you have some extra cash, then to the lump sum.
The problem with a lot of people is they aren’t disciplined enough to do lump sum, so they need to dollar cost average as it forces them to save a little bit at a time.
12 FourPillars // Oct 18, 2007 at 2:58 pm
Preet makes an interesting point about how we are in the 62th month of a bull market which is much longer than the average bull market.
While all the points about how we’ve enjoyed a lengthy bull market and it might crash any day are perfectly valid - they were also perfectly valid 30 months ago when the bull run was 32 months (the average) old. Had someone switched to cash (or stayed) in cash at that point they would have lost out big time.
I’m in no way saying that the market is going to keep going up but my point is that nobody can predict it very accurately. The other comment I see frequently is the idea that the market will have a big crash because it’s done so well. Yes, it’s possible but another way for valuations/earnings to even out is to have flat returns for an extended period which Katesenelson is proposing.
Summary - there’s nothing wrong with Todd spreading out his purchases but I would suggest he pick a limited time frame (6 months max) to get it all invested.
Mike
13 Canadian Capitalist // Oct 18, 2007 at 3:35 pm
Mike: I couldn’t agree with you more that this prediction business almost never works. I’ve been reading reports since 2005 that the bull is “aging”. Well, since then we’ve had only one sharp correction in two years. Is there a bear market in the future? Undoubtedly. When? I have no idea and I don’t think anyone else does either.
Even spreading out purchases provides no guarantees. Todd could patiently buy over six months and find that just after he makes his last purchase, the market tanks. That’s the nature of the beast and we don’t have a choice but deal with that uncertainty.
14 Todd // Oct 18, 2007 at 10:17 pm
Thanks everyone for your comments. I’m going to average the money in over the next few months
Todd
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