With global equity markets showing losses of 20% – 30% year to date, and bond markets having suffered their worst year since 1949, 2022 will no doubt go down in history as an ‘Annus Horribilis’ for global financial markets.
People come into money one of two ways; gradually or suddenly. Excess earnings saved during the course of a career versus the windfall generated from the sale of a business. Income generated over a lifetime from a portfolio of assets versus an inheritance.
For those who fall into the first ‘gradual’ category, timing investments is pretty easy – you invest a fixed amount into your pension each month, or you can set up a standing order to add excess income to a portfolio on a regular basis. Job done.
But what if you fall into the second camp, having come into money all at once? Or you could have been saving money over many years but never invested it, comfortable seeing the cash pile grow year by year with no change to the nominal (pre inflation) value.
If you want to invest some of this money, then when should you “pull the trigger”? This is clearly a more nuanced decision. Coming into a large, potentially life changing, sum of money, can come with a weight of responsibility to “do the right thing”. If you have spent the entirety of your working life building a business, which you have now sold, why should you not maximise the benefit?
Likewise, if you have never invested your earnings and it is siting entirely in cash, the realization that we are now living in a time of inflationary pressures may make you feel you need to do something positive to maintain the real value of your cash pile.
In our experience, there are two (or maybe two and a half) options. There are advantages and disadvantages to each option.
Option 1 – Invest the entire lump sum immediately
Yes, the portfolio might fall in value immediately after you invest. Yes, it might even fall by a lot. You might feel like the unluckiest investor ever, however the simple truth is that asset prices tend to go up over time, and the longer the time you invest the more likely this becomes.
If you picked any random calendar year going back to the beginning of 1971 to invest in global stocks, you would have ended the year with a positive return just under 75% of the time. The probability of a positive outcome increases as investment periods get longer. The odds are therefore on your side when you choose to invest.
But even if you happen to invest in the other 25% of years, (of which 2022 is highly likely to be one such year), and the portfolio falls initially, does this really matter? By definition, the decision to invest should only be taken when you do not need the money for a reasonable period of time, ideally five years or more. Having a longer-term outlook and investment horizon not only increases your probability of seeing a more positive outcome, it also mitigates the emotional impact of short-term moves. Time really is your best defence against volatility, the best weapon you can have against risk.
An overlooked advantage of choosing to invest everything on “day one” is simplicity. One decision to be made, over and done with quickly.
Some people value this simplicity when it comes to their finances and so making the period of initial investment as straightforward as possible can only help on this front.
Fewer decisions, fewer opportunities to make mistakes. As Warren Buffett says, “you only have to do a very few things right in your life, so long as you do not do too many things wrong.”
Option 2 – Phase the money in over time
Option one may be the default recommendation – the spreadsheet answer. However, humans are not robots and life does not exist on a spreadsheet. The primary benefit of option number two is that it can reduce stress during the period of initial investment. The dividends are psychological rather than financial. By phasing in gradually over time, each tranche of investment takes on less importance in monetary terms, and the chance of seeing a large initial drawdown in the value of your portfolio is reduced. This approach can be helpful if we are talking about more money than you have ever had to deal with before.
The data indicates however that there are clear reasons why you should choose option one. Firstly, the data is clear – asset prices tend to go up over time. Sitting in cash is a bet against history, and with inflation at or near double digits, potentially an expensive bet. Secondly, if the market falls during the period of phasing in your investment (making option two the “correct” choice), are you really going to continue to invest regularly? Markets do not fall in isolation, there is always a reason – will you be able to block out this reason, whatever it is, and stick to your initial plan? Thirdly, the cost of sitting in cash, thanks to inflation, is now higher than it has been in a generation. Although not obvious, inflation at current levels has a corrosive effect on cash which is sat on the sidelines – even over relatively short time periods.
However, if the second option feels like the right one for you, you should establish a rules-based plan at the outset (e.g. invest 1/12 of your money each month for a year) and stick to it. Phasing in investments without a plan, or “by feel” brings us to option three (or 2.5).
Option 3 – Wait for an opportunity to “buy the dip” or until “the coast is clear”
Option three takes the worst elements of option two and turns them up to eleven. We have only included it so we can warn you of the dangers.
Markets can, and do, behave in incredibly counter-intuitive ways. Nailing the perfect moment to invest all of your lump sum, or even a portion of them, would be like winning the lottery. It is a fairytale. Either a) you won’t get a better opportunity to invest than on “day one” (remembering that markets go up, more often than not); or b) you won’t feel brave enough to invest when you do get the opportunity. Again, when markets go down the narrative will naturally be worse, and investing will feel harder than when the news flow is better.
Of course, the temptation of trying to follow this approach is clear. It is natural to seek some element of control, and trying to pick and choose when you invest can feel like having control – but in reality this is just an illusion. At some stage, if you want to earn a return over and above that available from cash deposits, you are going to have to get your feet wet.
How we can help
Whichever option you feel most comfortable with, an experienced independent advisor can help you make the decision that is right for you.
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