Advisory FAQ: Is It Too Risky to Invest a Large Sum of Cash Now?

Kyle Olson, CFP®, and Partner at QA responds to frequently asked questions about investing large sums of cash into the stock market, especially when market values are high.

Kyle, what are the key points someone should think about when considering investing a large sum of cash into the markets, including potentially using dollar cost averaging?

Kyle:

First, let me acknowledge that especially when investing a large sum of cash there are always emotions involved…concerns around the “is this the market top” question.  It honestly boils down to two potentially competing objectives. First, concern around near-term declines and, second, the potential for long-term gains.  The first comes down to managing risk, and the fear of regret of investing at the wrong time.  When this is the primary concern, it typically makes sense to dollar cost average (DCA) or invest portions of the cash over a period of months or quarters.  While the investor may miss out on some near-term gains by keeping some cash on the sidelines for several months or quarters, it reduces risk in the event of a large market decline in the near term.  This is typically the more palatable approach as it helps to manage risk.  For this approach to “pay off” versus investing the lump sum all at once, you would need to experience a market decline of some sort within the DCA period to end up ahead of the game financially.  So, DCA is often an approach focused on providing some peace of mind.

You mentioned a comparison to the potential of long-term gains.  Can you say more about that?

Kyle:

Well, we know that for markets to go up over time that means that there are more positive days than negative days.  Long term data1 shows us that historically the US stock market has been positive about 53% of the days. That correlates cumulatively to about 63% of the months and 69% of the quarters that markets have been positive.  The potential of being better off investing a lump sum vs. dollar cost averaging  into the market over a quarter lean toward investing a lump sum.  Some might say, why not DCA over a longer period?  Well, historically positive market periods only jump another 5% to 74% positive over 1 year.  So, you can see why timing the market, especially when time horizons are 3-5 years or more, is much less important than time IN the market.

How does this further relate to taking withdrawals, especially throughout retirement?

Kyle:

We think about managing risk through a retirement withdrawal period a little differently.  Largely because the time horizon for the distributions is shorter, often monthly, for the distributions, and taking the risk of market drawdowns on monthly withdrawals (37% down months historically).  We think of that as “sequence of return risk” especially applicable during distribution.  We manage that risk  through planning and knowing what the total amount of withdrawals are going to be for the first 3-5 years.  We then separate the portfolio into “buckets” that segment the portfolio according to the timing of the need.   We invest enough of the portfolio (being intentional on tax status of investments) to satisfy those needs in a lower risk, often tax-free bond portfolio, or bucket one.  That allows us a 5-year time horizon on a second bucket of money that we might take 50-60% equity risk in, knowing that markets have been positive 88% of the time over 5 years.  That allows us to segment a third bucket of the portfolio in a more aggressive posture knowing we have a 10 to 15-year time horizon on those assets.  It really allows us, and our clients, to know exactly where income is coming from, when, and why… and helps to alleviate emotional risk during inevitable market pull backs when they are largely occurring in buckets two and three.

Any closing thoughts?

Kyle:

I would say it’s always helpful to be thoughtful about investing large amounts of cash into the capital markets.  There are tools and charts and analysis that your advisor might be able to utilize to help clients decide whether to DCA or not, and over what time frame.  Regarding the conversation around time segmenting portfolios throughout retirement, I would just say this is generally a great way to help manage risk throughout retirement to effectively create a “paycheck” from your portfolio.

Meet with your advisor or contact us today to talk further about your important investment planning.

 

Historical Frequency of Positive Stock Returns, Fisher Investments (February 2018)

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™, CFP® (with plaque design) and CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

The information in these Advisory FAQ drawn from “Historical Frequency of Positive Stock Returns” authored by Fisher Investments uses historical S&P 500 Index returns from January 31, 1926 through December 31, 2017 (for monthly, quarterly and annual return data, reflecting total return) and from January 31, 1928 through December 31, 2017 (for daily return data, reflecting price appreciation only).

The index performance results referenced in this report represent past performance and are not a guarantee of future performance. Investment returns and principal value will fluctuate and are subject to market volatility, so that a client’s investment, when sold, may be worth more or less than the original cost. Indices are unmanaged and investors cannot invest directly in an index. An index’s performance does not reflect the deduction of transaction costs, management fees, or other costs which would reduce returns.

The S&P 500 Index is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the New York Stock Exchange or the NASDAQ Stock Market.  For more information regarding this index, please refer to the sponsor website at www.standardandpoors.com.

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