I’m often asked how to invest a lump sum of cash. Should this money be invested in the markets all at once or phased in over time?
The answer depends on several factors: where the money came from, the amount relative to your current savings and how it was invested before you received it. Lump sums can come from several different sources — a pension pay-out, inheritance, the sale of property or a business, or perhaps winning the lottery.
The value of advice
Figuring out how to invest a windfall to ensure long-term financial security can be a challenge at any time, even for an experienced investor. But this isn’t just any time. The rand doesn’t know up from down, shares have experienced some scary volatility lately and this bull market is looking a little long in the tooth. Surely, we’re due a correction?
In this market, even a seasoned investor has their work cut out for them. That said, one should never approach investing with fear. If you have an adviser you trust – one who can guide you should you run into trouble – then a difficult task is made easier. Good advice is worth every cent. If you think investment advice is expensive, just try ignorance. An adviser will help you approach this task in a thoughtful, methodical and disciplined manner. I personally think that anyone should be able to invest their money in a way that can secure their retirement and perhaps their children’s future as well.
Going all in
Research shows that most of the time, a lump-sum investment will outperform the alternative (phasing it in over several months), purely from a mathematical perspective. Vanguard’s researchers crunched the numbers using historical returns and a hypothetical portfolio consisting of 60% shares and 40% bonds, and they found that in the US, UK and Australia, the same conclusion held true: an immediate investment usually outperformed a systematic one. It’s not the Alsi (JSE All Share Index) but the maths still holds.
There were only a few short-term periods in history when that wasn’t the case, and no surprise here – it was during a market crash. Most of the time, the market trends higher, and when it does, the lump sum method generates returns that on average, are a few percentage points higher than a systematic approach that rolled out the same investment over a series of 12 months.
This is because markets typically trend in an upward manner – so in most cases, if you leave cash sitting on the sideline as you wait to contribute via phasing, markets will appreciate before you can invest. That means that you will be buying in at a higher cost and realising lower investment returns.
Pay off debt
If you are carrying debt on a high interest credit card with 15% to 30% interest, you will have a better rate of return by putting the lump sum towards your debt, than you would investing it. That’s my opinion. Even with the option of putting the lump sum in a retirement account, and thus possibly making you eligible for a tax rebate, overall the math doesn’t work. This is for three reasons:
- The tax refund comes several months later, and you are paying interest in the meantime.
- The refund likely doesn’t cover the full interest costs on credit card debt for a year.
- You only get a tax break once per annum; the credit card debt remains until it’s paid in full.
Instead, I suggest paying down your debt and using the amount you saved in interest or monthly premiums to invest into a retirement annuity. Ultimately it depends on math and risk. In the case of high-interest credit card debt, running the numbers can show that paying down debt makes the most sense. With other debts, ask yourself how much risk you can tolerate. Paying off debt is a guaranteed return. You reduce your risk to unforeseen events and likely will sleep better at night.