Brian Littlejohn/Courtesy photo
What should you do if you’ve just received a big bonus at work, inherited some money, sold a business, or otherwise enjoyed a recent windfall you’d like to invest? Should you invest the money right away — even if the market seems particularly high — or little by little over time?
This is a question I often hear from clients and other investors. It’s no wonder; deciding how to invest a pot of money can indeed feel paralyzing. What if you put the money into the market and it promptly nose dives? Or what if you hesitate, and the market soars? It’s perfectly normal to worry that you’ll make the wrong move … or at least not the most lucrative one.
Investing a lump sum all at once or over time each has its advantages and disadvantages. Let’s take a look at some of the factors to consider.
Begin with your goals
Before making any investment moves, first consider what you want to use the money for.
In the short term, the market can be a volatile place, with the potential for large ups and downs. If some or all of your money is going to be used for short-term goals — say, paying college tuition bills that are just a few years away — you may want to consider more conservative investments that are less affected by this volatility. Some of these more conservative investments include things like money market funds, short-term bonds, and certificates of deposit (CDs).
If you want that money to help you pursue long-term goals such as retirement, then investing in the stock market right away is likely to be a prudent move. Over the long term, volatility tends to smooth out and the markets have historically continued to march higher.
Compare lump-sum investing vs. dollar-cost averaging
When you invest a lump sum, all your money is exposed to the market right away. If the market is on an upward trajectory, you can take advantage of immediate gains.
But of course, near-term market returns are not predictable. There could be a downturn after you invest your lump sum. If this potential for a setback right out of the gate bothers you, dollar-cost averaging — investing a set amount of money at regular intervals — may be a more comfortable strategy.
For example, you could use dollar-cost averaging to invest $12,000 in a low-cost, total market index fund in $1,000 monthly installments over a year. That way, when the market is relatively expensive, your investment buys fewer fund shares. And when the market is cheaper, your investment will buy more shares. This strategy helps you take advantage of the market’s natural ups and downs, helping you manage the average cost of the shares you buy.
However, be aware that the greater comfort that comes with spacing your investments out over time through dollar-cost averaging may come at a price. Research has shown that lump-sum investing outperforms dollar-cost averaging 68% of the time.
So, ask yourself: Is maximizing expected returns your top priority? If so, the lump-sum approach might make the most sense for you. On the other hand, the same research I just mentioned finds that the lump-sum strategy’s expected outperformance is not huge. As such, if the possibility of large investment losses is likely to keep you awake at night with worry, it may be worth taking a small performance hit to use dollar-cost averaging instead. This is especially true if doing so reduces the chance that you will engage in panic-induced selling during a market drop, which can effectively lock in even greater losses.
Whatever you do, don’t delay
Historically, stocks and bonds have outperformed cash holdings over the long term. It’s critical to start investing as soon as possible to take advantage of this outperformance. As the saying goes, the best time to invest was yesterday and the second-best time is today.
Delaying putting cash to work in the market is a form of market timing — buying or selling shares in an attempt to predict future market movements. This is a complicated game you’re unlikely to win. Consider that average equity fund investor returns trailed the market (as proxied by the S&P 500) by 5.5% in 2023, largely due to investors trying to time to the market. Both lump-sum investing and dollar-cost averaging help you avoid this behavior and take advantage of the tendency for the market to grow over the long term. And this is what you need to meet your long-term financial goals. The important thing is to choose the strategy that will allow you to stick to your long-term plan.
I wish you and yours a healthy, successful, and memorable 2025.
Brian R. Littlejohn, MBA, CFP®, CFA is the founder of Sherwood Wealth Management, an independent, registered investment advisor (RIA) firm that specializes in inherited wealth. He lives in Aspen and works with clients in the Roaring Fork Valley and beyond.
