If you have cash to invest – now or in the near future – what is the best way to do that?
This is a common question we’ve heard over the years, and it is particularly important at this point in time. The major market indices are down roughly 20% year-to-date and smaller company stock indices have lost 30%. But, even more importantly, the volatility index (or VIX) is trading near historically high levels.
Should you invest it all-at-once in a lump sum or invest gradually over a period of time? Given the current conditions of the market, we advocate for investing the proceeds systematically over time. That time frame can be anywhere from three months to 18 months.
Whether you have a liquidity event coming up or you already have cash from the sale of an illiquid asset (such as real estate or a business), we believe that investing it gradually makes the most sense given the volatility we’re seeing. Even though the markets are down considerably (despite improvements in the last week), things could still get worse from here. Conversely, even if market trends continue upward from here, it is likely that the high levels of volatility we’re seeing will continue for some time.
In other words, that path will likely be very jagged regardless of the general direction of the market. And the advantage with a systematic – or opportunistic – investment plan is that you can take advantage of that volatility. A plan for investing equal amounts over a period of time means that the swings in the market will generally work in your favor because you are buying less shares at higher prices and more shares at lower prices.
Here is a comparison that shows how that works:
For purposes of comparison, we considered the 08/09 timeframe, which was the last time we had levels of volatility similar to what we’re currently experiencing. We assumed the availability of funds from a liquidity event in June of 2008.
What you can see in the top section labeled, “Lump Sum Purchase,” is if you had $4.5 Million and invested it all at once, you could buy about 35,000 shares of a proxy representing the S&P 500 Index. If, on the other hand, you invested it systematically with six quarterly investments of $750,000, you end up buying 10,000 more shares with the identical total amount invested.
If you look at the examples pertaining to the “Systematic Purchases,” you’ll see that there are more shares purchased when the price is low and less shares purchased when the price is high. That is the concept behind a systematic purchase plan, and it works really well in a market that is extremely volatile. That is why we believe that this is a point in time where that approach will succeed.
The chart below compares the dollar value of the lump sum investment with the systematic purchase plan. The small circles represent purchases. The blue line shows a lump sum investment at the end of June 2008 through the end of 2009 as compared to quarterly buys over an 18-month period represented by the red line.
You can see there is a significant difference in final balances. The total amount invested is shown by the black line ($4.5 mil). There is more than a $1.1 million difference between the two approaches. The lump sum investment lost value from $4.5 mil to less than $4.0 mil at the end while the systematic – or opportunistic – buys appreciated from $4.5 mil to $5.1 mil.
Given the heightened levels of volatility in the markets, our bias at this particular moment in time is a strategy of opportunistically buying in over a period of time rather than investing all at once. It is important to note that this is not always the case. There are times when the opposite is true, and a lump sum investment can outperform. But right now, if you’ve had a recent liquidity event or expect to have one soon, we would recommend investing it gradually.
To learn more about our current market outlook, check out this web page which aggregates all of our COVID-19 related commentary.
This is a hypothetical example and is not representative of any specific investment. Your results may vary.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.