Lump Sum to Invest?

Natasha* inherited $800,000 from her dad. She wants to invest this money to help supplement retirement. What are her options?

Generally, there are two ways one can invest their money:

1.  By making a lump sum deposit
2.  By investing over time

(A third way could be to invest some of the lump sum and the balance over a period of time.)

In Natasha’s case, she would be able to utilize any of these options.

Some, have no choice.  Let’s say you have a 401k retirement plan at work.   Your only real option is to invest over time from your paychecks.  

This strategy works really well for a couple of reasons.  First, it is on autopilot.  Once it is set up, there is no real thinking involved.  Money from your paycheck simply goes into the investments you have chosen.

This is called Dollar-Cost Averaging.   You are investing the same amount of money each period.  Whether that is weekly, bi-weekly, or monthly.  It doesn’t really matter as the principal is the same.

The “investing over time” method has another advantage that could be appealing to some.

Let’s say for example, you are investing $250 a month and you suddenly see your investment going down in value.  It looks something like this:

Let’s further assume you are not working with a Certified Financial Planner® practitioner and you start getting nervous.  Since the price is going down, you think it may be better to wait a bit and start investing again when the price goes back up and it is safer.

Wait.  Let’s read that again after looking at the chart.  You are investing $250 a month and since the price is going down, it looks like you are buying more shares as the price goes down.  At $7.00 a share, you are getting about 35.71 shares while at $10 a share you only got 25 shares.

The reason one may feel it is safer to invest when the share price is rising is merely psychological. It is human nature to want to see an investment (whether a stock or real estate) go up in price.  We rationalize that if the price is rising it must be a good thing and provides more safety.

However, when dollar-cost averaging, (Investing over time) buying more shares with the same investment can provide for better long-term results over time. 

Bear in mind, that dollar cost averaging is not a guarantee that one won’t or can’t lose money.  When investing in stocks, there are risks involved and loss of principal is definitely one of them.

Getting back to Natasha, since she does have a lump sum to invest, she has options that the 401k participant doesn’t.

She could just plunk the full $800,000 into an investment if she chose.

The real question is, should she.

According to this article by FINRA [1] in a 2012 study by Vanguard, they found that historically investing in a lump sum vs dollar-cost averaging produced better results 66% of the time.

So, what should Natasha do?

Here is where sitting down with a Certified Financial Planner® practitioner can make a huge difference.

I would ask Natasha some questions like…

1. How old are you?
2. How soon would you be using this money?
3. Do you have any short-term goals that this money would be needed for?
4. Do you have other investments?
5. Do you have an emergency fund of at least 3 to 6 months of living expenses?
6. Have you done a comprehensive financial plan lately to see if you are on track to meet your goals?
7. What would you do if your $800,000 investment went down in value 6 months after investing?

After having this conversation, we could then better determine what would the best move be.

For example, assuming she didn’t need this money for 20 years, had an emergency fund, no short term need etc., then I would focus on how she would feel if this investment value went down.

If it would cause her many a sleepless night, dollar-cost averaging might make more sense.  This way, only a portion of her money is subject to the downturn.

Another option could be to invest a portion and then dollar-cost average the rest.

Last but not least, depending on what types of investments one is making, i.e. stocks, stock mutual funds, bonds, etc, can play a big role in this decision as well. Remember, no two individuals are the same.  What is right for Natasha may not be right for you.

As always, when making big financial decisions, it is always best to speak with and take the advice of a Certified Financial Planner® practitioner. Any questions, we are here to help.

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All the best.

Rick Fingerman, CFP®, CDFA™, CCFS®

Rick@PlanWithFPS.com

617-630-4978

*Not her real name

** Rounded number of shares acquired.  Dollar cost averaging does not ensure a gain or protect against a loss.

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.

[1] https://www.finra.org/investors/insights/three-things-know-about-dollar-cost-averaging