It’s not uncommon to find yourself in a situation where you have a lump sum of cash (from selling a home, an inheritance, savings having built up in the bank, etc.) that you want to invest but are having trouble deciding whether to do it all at once or in a gradual manner. It can be easy to get hung up on this decision, especially if you don’t fully understand the pros and cons of each approach and how they apply to your situation. In fact, the uncertainty can often become enough of a roadblock that it leads to inaction and the money just sitting there (or even continuing to pile up as you save more). Therefore, this episode is dedicated to sharing some perspective for how to think through the decision and decide which approach is right for you.
Outline of this episode
- Putting your cash to better use [1:19]
- Investing everything all at once [3:31]
- Dollar cost averaging [9:43]
- The importance of having a plan [14:38]
- The recap [17:54]
Investing all at once
Two of the main benefits of investing all at once are that 1) it's the easiest logistically, and 2) historically it's been the financially optimal approach since the stock market has gone up more often than it's gone down, so the best time to invest has been as soon as cash becomes available. On the flipside, the drawbacks of this approach include the risk of having bad timing (where you invest immediately before a stock market pullback or a bear market) and the mental and emotional considerations where it might not feel good to do it this way and can be difficult to actually take action because of the timing risk.
The gradual approach
If you don't invest all at once, the other option is to follow some type of gradual approach of investing the money bit by bit until it's all invested, which is known as dollar cost averaging. The main downside of dollar cost averaging is that it's more difficult to implement logistically (since there's more work involved) and historically it hasn't been the financially optimal approach. However, the key positives are that it often tends to feel better from a mental and emotional perspective, and if you happen to invest during a period where the stock market is either declining or is fluctuating upward and downward, but generally trending sideways, you'll end up doing better financially than the all at once approach.
Having a plan is important
One of the most important things is to have a plan, regardless of the exact form that plan takes. The reason why having a plan is so important is that it helps you remove the emotion, guesswork, and behavioral bias from the process and therefore makes it more likely that you'll be able to avoid getting in your own way.
Two specific things to mention are the cycle of greed and fear and the asymmetry of gains and losses. With greed and fear, the way it works is that when the stock market is going up, people tend to feel good and are more inclined to believe that it's a good time to invest money. Whereas when the market's declining, fear and negative emotions tend to kick in and people are often more worried about investing in a falling market (which when you think about it is the opposite of how investing actually works). When it comes to the asymmetry of gains and losses, keep in mind that people tend to dislike losses more than they enjoy gains (often by a factor of around two-to-one), which ties back to the timing risk/concern around investing a lump sum of cash all at once.
Resources & People Mentioned
- Podcast episode #3: The 80:20 Rule of Investing
- Podcast episode #19: The “Other 20%” of Successful Investing
- Podcast episode #30: How to Manage the Emotions of Investing
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup