Let me guess. You’re sitting on a hoard of cash after having been traumatized by the failure of financial markets back in 2008. Every time the market jumps up by a quick 30 percent, you think, “I should have invested.” Then the market dives once again and you’re glad you’re still liquid. Like Scrooge Mc Duck, you just love that money bin.
There’s a good reason to be paranoid when it comes to the stock market. Andrew Ross Sorkin’s incredible account in the book, “Too Big To Fail” is now also known as “Too Long to Read.” But, it chillingly outlines the extent to which Wall Street’s Masters of the Universe were all running around like chickens with their heads cut off. At one point, when Congress first voted against the bailout, Treasury Secretary Henry Paulson threw up in a waste basket. He, for one, understood that the banking industry was on the verge of collapse and that banks around the world were within days of having to close their doors -- and shut off their ATM machines. Just imagine what that would have looked like. Nancy Pelosi did just that and muscled through the eventual bailout.
It’s slowly sorting itself out now, of course, but not before major financial institutions whose business was to offer sound financial advice to others had wound up going broke themselves. Merrill Lynch and Morgan Stanley come to mind. Even Goldman Sachs was at death’s door until we allowed them to become a bank (free toasters for new accounts?) so that Warren Buffett felt comfortable investing $5 billion to keep them afloat.
So, in the light of that slippery slope represented by Wall Street, what better use do we have for cash. If we can bring ourselves to tip toe back into the market, do we do that in one fell swoop or by dollar-cost-averaging with regular incremental deposits?
The April 12th AAII Journal put out by the American Association of Individual Investors offers a study showing that, at least from 1999 to the present, a lump sum deposited into a mix of different investment types beat the results of income averaging. This is surprising, because one would think that two major market crashes during that period would have offered opportunities for dollar-cost averaged money to benefit from purchases at lower stock prices during the two major declines of the period. The exception was the S&P 500 index which generated better returns from dollar cost averaging.
What made the difference, apparently, were dividends. A collection of mutual funds invested in utilities, health care, industrials, financials and consumer staples all helped protect against the downside more effectively than the 500 index, but their overall increased return was a function of higher dividend payouts on average. Reinvested dividends, in general, constitute 25 percent of a stock’s overall performance, so it is possible to see how a lump sum invested up front would have had the entire amount of money earning at least something on a regular basis compared to money markets that were earning nothing for the better part of the period.
Also, what we know is that the S&P 500 index was dragged down by the large banks that struggled -- not to mention the auto industry. Just a handful of huge companies make up almost fifty percent of the value of the index, so given the volatility of some of the behemoths the value of the index dropped substantially, and then recovered.
So, which is better -- lump sum or dollar-cost-averaging? There is no right answer. The correct answer depends on your psychological disposition. It you would be bent out of shape at the thought of losing a lot of money right after committing your carefully hoarded cash to the market, it would be better to dollar cost average. On the other hand, a lump sum committed to a broad cross section of investment types has proven to be a better alternative for even the most skittish. Put things into perspective. Your cash is currently losing 2.5 percent per year as inflation eats away the value of your money that earns nothing. Think about that as you lie on the beach, and while you’re at it, consider joining AAII for their practical investment advice and regional network of investment support groups.