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There is an age-old debate among investors as to whether it is better to invest a lump sum as soon as possible, or to spread your investments over time. The reason the debate still rages is that there simply isn’t a right or wrong answer.
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Both lump sum investing, where you put all your money in at once, and dollar cost averaging, where you make regular investments over time, have their strengths and weaknesses. When considering which path to take, consider your personality as an investor. For some, putting all your money into one investment at once amounts to “putting all your eggs in one basket,” which can seem risky. Others approach the debate with the belief that getting money into the market as soon as possible gives you more time to earn a return.
To help you understand which might be the best option for you, here’s a look at the pros and cons of lump sum investing.
Pros: Potentially higher returns
Wall Street is full of axioms, and one of the most quoted is that “it’s the timing of the market, not the time.” What this means is that over time, the power of compound interest can really affect your earnings. The longer you invest, the more time you’re giving compound interest to work its magic.
For example, if you invest $10,000 at a 10% return for 50 years, you’ll end up with about $1.45 million. But if you wait just 10 years and invest that money for just 40 years, you’ll only have about $537,000. Starting investing just 10 years ago nearly triples your bottom line, and that’s something most people would consider pretty significant. Investing your money as soon as you can in a lump sum can give you more time in the market than investing a little at a time, so it can offer you the opportunity for a higher total income.
Cons: Coming with a lump sum
One of the problems with lump sum investing is that not all investors have a pile of cash just lying around. In fact, if you’re just starting out, waiting to build up cash reserves to invest can actually counter one of the supposed benefits of lump sum investing, which is investing as soon as possible.
If it takes you months or years to accumulate a large sum to invest, you will actually be wasting time in the market instead of profiting from it. Instead of waiting to build up your lump sum, you can spread that money out little by little instead of letting it accumulate in a savings account.
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Pros: No need to time the market
Remember the Wall Street axiom of “timing the market, not the time?” The second half of this phrase is another troublesome idea for most investors. Timing the market is difficult, stressful and often emotional. Market timers tend to put their money in when the market is booming and they feel euphoric, which often marks market tops. They also tend to withdraw money when the market has fallen sharply and sentiment is negative, thus losing when the market pulls back.
However, if you invest a lump sum, you don’t have to worry about timing the market because you’re only investing once. This can take anxiety, stress and time-consuming market research out of your daily life.
Cons: Potential portfolio loss
When you put all your money into the market at once, you run the risk of investing right before a correction or a bear market. Although over time the markets have always recovered from sales, it can be emotionally difficult to sit back and watch your entire portfolio drop by 10% or 20% at once.
If you are not disciplined as an investor, you may feel a compelling urge at this point to withdraw your money, which can be disastrous for your long-term returns as you close your loss and then watch the market go higher.
Pros: Puts money to work as quickly as possible
Money that doesn’t work can actually cost you financially. Even if your money is in a savings account that earns 2% interest, after taxes and inflation, you are no doubt technically losing money in terms of real returns.
That’s why it’s so important to get your money into higher-yielding investments like the stock market as soon as possible. Investing in a lump sum is the fastest possible way to get your money out while earning a higher return, and in the long run, it can pay huge dividends. In this sense, waiting to invest monthly, quarterly or annually rather than immediately can cost you money.
Cons: Exposure to volatility
If you have only invested a little in the market, the volatility may not bother you. In fact, it can be an opportunity, since when the market is down, you will still add more money to your account and buy stocks cheaper.
But if your entire portfolio is on the market at once, even a modest selloff can be scary. For example, if you put $200,000 into your account all at once and the market drops 10%, you’re suddenly looking at a loss of $20,000. That’s a significant amount, especially if you’ve just invested all that money.
Pros: Only one brokerage fee
By investing a large amount, you don’t have to worry about recurring brokerage fees. If you use a commission broker, each time you invest you may have to pay a fee, whereas with a lump sum, you will only pay that fee once. If you use a commission-free broker, you may face other fees or restrictions, such as a small trading fee, a minimum balance requirement, or an account maintenance fee that is a higher percentage of your total portfolio. Whatever fees you may encounter, it’s better to be able to pay them once rather than repeatedly.
Cons: Not a 401(k) replacement.
Investing as much as you can yourself is a great idea. However, for most Americans, a retirement plan like a 401(k) is still the best option for building a nest egg. For starters, you’ll get a tax deduction for your 401(k) contributions, and your money will grow tax-deferred. This alone can put you ahead of the game when it comes to investing.
However, most employers will also match a certain percentage of your 401(k) plan contributions, and that’s the closest thing to “free money” you’re likely to ever get. Over time, those annual matching contributions can grow to become a significant percentage of your final nest egg. If you try to use a lump sum investment as a 401(k) replacement, you’ll likely fall short of what you could have achieved if for no other reason than you won’t have those extra contributions made to your account. every year.
Pros: ‘Set it and forget it’
One of the biggest advantages of lump sum investing is that you can simply purchase your investments once and be done with the process. For many people, trying to analyze investments and deal with daily market fluctuations can be overwhelming and stressful. But if you put all your money in once and let it be, all those worries disappear.
Assuming you’ve chosen a portfolio that’s consistent with your investment objectives and risk tolerance, if you invest a large amount, you can essentially “set and forget” your portfolio, subject to occasional review.
Cons: Possible impulsive choices
One downside of throwing all your money into a portfolio at once is that you’re likely to invest in stocks you’re interested in at that point in time. In other words, you may be susceptible to impulsive choices. In addition to long-term investments like Berkshire Hathaway or Johnson & Johnson, for example, you might be passionate about meme stocks like AMC Entertainment or GameStop.
While some traders can and do make money flipping these volatile names, they may not be ones you want to hold for, say, 40 years, and you certainly don’t want to put your entire portfolio into them. So if you only invest once and “set and forget” your portfolio, you may not be nimble enough to prune speculative names if they’re crashing.
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