Should You Invest a Lump Sum All at Once?


There was an interesting article in Money magazine this month about dollar cost averaging.  Typically, this is where you would buy investments at regular intervals, for example putting $500 per month into a mutual fund over a period of several years.  The idea is that then you buy shares both when prices are high and low, buying more shares when they are low (since you’re putting in a fixed amount of money each month).  Buying more shares when prices are lower means that you’ll get a cost basis lower than the average stock price for the period over which you were buying, so even in a flat market you’ll make a small profit.  Dollar cost averaging is a great idea since it 1) does get you a good price and 2) gets you putting away money regularly, which is the secret to becoming financially independent.

What the article was really talking about, however, was whether it was better to invest a lump sum all at once, or invest a portion of the money each period over several periods.  For example, if you got a $1M inheritance or a big lump sum payout from a pension fund, should you invest it all at once or maybe put in $50,000 per month for a couple of  years.  Their conclusion was that it is better to just drop it all in at once.  I’m not sure I agree.

        

Find Books on Investing from Amazon

They cited a study by Vanguard that showed that you’d be better off 2/3rds of the time just investing all at once than spreading it out over several periods.  This makes sense since the market goes up about 2/3rds of the time.  Their reasoning for doing so despite what happens the other 1/3rd of the time – when the market declines after you invest – is that if you plan to put 60% in stocks and 40% in bonds, for example, you’re already investing to manage risk.  It therefore makes little sense to hold back cash and go against your investing plan.

The problem I have with this plan is psychology.  It would be devastating for most people to invest the $1 M they’ve gathered up all of their lives in their pension plan and see a 40% loss as we saw in 2008.  It would be even worse to see another event like the market crash of 1929 where 90% of the value was wiped out and it was more than 15 years before people were back to even.  Many people would simply cash out and go into T-bills and bank CDs after suffering through such an event.  As we saw in 2009 and 2010, this is often exactly the wrong thing to do since markets have almost always recovered fully from such events within a year or two (1929 being the exception).  If someone invested just $100,000 of a $1 M lump sum right before the drop, hopefully they would see it as an opportunity and continue to invest in regular increments.  Even in 1929 they would have made out like bandits this way because it is right after large drops that the market is on sale.

Learn how to use mutual funds from the founder of Vanguard:

 

 

 

 

 

 

So yes, statistically it is better to invest all at once, but psychologically it is better to wade in slowly. The consequences of dropping a large sum into the market right before a major event are also so severe that a 66% probability of doing better just really isn’t worth the consequences of being wrong.

Even when building up  position in a stock I tend to wade in, rather than taking the plunge all at once.   For example, if I wanted to build up a 1000 share position in BJ’s Restaurants International (a company I usually have a big position in and which I have on now), I wouldn’t typically just put $40,000 into it to buy 1000 shares at $40 even if I had the cash sitting around.  Instead, I might buy 200-300 shares, gather up more cash over the next month or two, then buy another 200-300 shares.  If the stock drops in price, I might use the opportunity to buy more shares at once.  Doing so actually makes drops in share price a good thing that I look forward.

Join the conversation and help make this blog more exciting!  Please leave a comment.  Also, if you have an investing question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

It’s not the individual choices – It’s the habits


 

I’m still making my way through Darren Hardy’s The Compound Effect.  One of the things I’m beginning to understand is that it isn’t the individual choices we make that set our destiny so much as the habits we form.  For example, right now I’m trying to lose the 50 pounds or so I gained back after dropping the same weight several years ago.  The last time I lost weight it was because I had changed my habits.  I regained it when I changed them back.

You see, back in my mid-thirties I realized that I was going to die young if I didn’t lose some weight and start exercising.  I started jogging about 3/4 of a mile in the morning, then walking back.  This continued three mornings per week for about three or four weeks (and I hated starting every time, but was always glad when I had finished my jog), at which point I was able to jog all the way out and back, running 1 1/2 miles per morning.  After this I would walk around the block (another 1/2 mile or so),  After a month or two of doing this, I started running around the block instead of walking after going out and back, increasing my total to about 2 miles.  Finally, after doing this for several months, I increased the distance I went out, upping my run to about 2.25 to 2.5 miles.  At that point I decided the run was far enough and running farther would just wear out my body.  I was able to run 5K’s and actually registered a time in the mid 20-minute range.

The Compound Effect

I also changed how I ate.  Instead of cleaning the plate when I went out to eat, I would eat about half and then save the other half for lunch.  I found that the whole meal would be about 1500 calories, so eating a half portion was about right.  At home, I would leave one thing off, like the side of corn or maybe the potatoes.  At Mexican restaurants I would just have a few chips rather than finishing the bowl and asking for a second or a third.  One thing I noticed was that when you’re out, many of the things you do centers around food:  stopping for ice cream, pie and coffee, or just a sugary coffee drink.  I found other things to do that didn’t involve eating.

As a result I went from a high of about 248 down all the way to about 215 pounds.  My pulse had dropped to about 50 beats per minute, to the level where they would need to take a couple of readings and get one over 50 before they would let me give blood.  I had a lot more energy, my blood pressure was lower, and generally I was in good shape.

For more information on why you can have too much diversification, try one of these great books:

        

Then life started to get in the way.  While I was exercising regularly, I often didn’t really want to get up and go out into the cold to jog since it was hard to get going to the point where I fell into a rhythm.  (After I would started, however, I discovered that actually the best temperature was about 35 degrees or so since I could wear a sweatshirt and cap and not get sweaty about half way through, so I preferred cold mornings to one that was in the 60’s or 70’s.)  When I reached about 39, however, I started getting heel spurs which would cause my feet to ache if I tried to walk after sitting for a while.  Jogging would cause the condition to worsen for several days after.  As a result, I stopped jogging as much, then finally quit entirely.  I changed my habit of exercising.

I also found myself eating more full meals when I went out to eat.  I also started getting soft drinks again in restaurants (I went to water before).  Worst of all, I started doing more business trips and vacations, where I would be eating out every meal and having a big breakfast at the hotel.  (I normally didn’t eat breakfast, so that added another 50 to 800 calories onto my diet each day.)  I went back to 220, then 230, then into the 240’s.  Finally, after a few holidays and trips, I found myself in the 250’s, higher than I had ever been.

Learn how to use mutual funds from the founder of Vanguard:

 

 

 

 

 

 

From reading The Compound Effect, I realized that what got me into such great shape was that I changed my habits.  It wasn’t the first day I went jogging or the choice of having water at lunch instead of a Coke one day that made me lose weight and get into shape, it was the habit of doing those things.   Likewise, changing habits back to eating full meals out and drinking a soft drink more often than not when we went to a fast food chain caused me to go right back to where I had been and then some.  Once again looking at an early fifties heart attack, I’ve changed back, cutting my meals and counting calories to stay below 2000 per day.  As a result, I’m down to 242 again.  I plan to stay with this, and start jogging again after I lose another five pounds or so (so that it isn’t as hard on my heels) and keep those habits this time.

So what does this have to do with personal finance?  Well, just like with losing weight and getting healthy, putting yourself onto a firm financial footing doesn’t mean doing one thing and then going about your life.  If you stick $100 into five shares of Intel Corp today and never do anything else, you won’t retire a multimillionaire.  But if you put away $100 every week or two and invest regularly, you’ll find yourself in 20 or 30 years financially independent.  It isn’t the individual choices – it’s the habits that make the difference.

So what are your habits?  Are they good, taking you where you want to go, or bad, holding you back and making you unhealthy or poor?

Join the conversation and help make this blog more exciting!  Please leave a comment.  Also, if you have an investing question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Figure Out How Much You Need to Retire


Early on, when we first started planning for financial independence, one of the first things we needed to determine was how much we would need to accumulate to retire and maintain our standard of living.  Having read a few books and newspaper articles, it appeared that the research suggests that you can withdraw about 3-4% of your portfolio value per year to use for living expenses without ever depleting the value of your account.  This figure includes allowance for inflation, since the idea is that you earn 8% or so on your portfolio (on average, assuming a mix of bonds and stocks), so your portfolio value (in dollar terms) will increase 4-5% each year over your retirement.  This means that in 15 years your portfolio will be twice as large as it was when you retired, and therefore able to provide twice the income in dollar terms, to make up for each dollar only buying half as much.

Determining how much you’ll need for retirement once you know you can withdraw 3-4% per year is really fairly straightforward. You simply figure out how much you’ll need in the way of yearly income during retirement, then multiply that by twenty-five. This assumes that you’ll withdraw the maximum of 4% from your retirement account each year, which will be invested in an appropriate mix of mutual funds and cash. If you want to be a bit safer, multiply by thirty-three, which will assume you’ll only withdraw 3% per year. This will increase your odds of outliving your money and accounts for stocks and bonds perhaps earning less per year than expected in the future – something economists keep predicting will happen and very well might if the government keeps growing and imposing all sorts of wasteful and protectionist regulations.

Books on Business and Investing at Amazon

For many people, something around a million dollars is reasonable, which provides an income of about $40,000 per year. If you have paid off your home and your cars, such that all you need to buy is food, clothing, and utilities, that is fairly reasonable. You will also probably want to save an additional $150,000, or $300,000 for a couple, to pay for medical expenses in retirement. So that puts minimum retirement savings at about $1.3 M. To be more conservative, shoot for something around $1.5 M.

 

So, the formula would be:

Minimum Retirement Savings = (Income Needed)*(25 or 33) + $300,000

for a married couple. For a single it would be:

Minimum Retirement Savings = (Income Needed)*(25 or 33) + $150,000


Magazines from Amazon

This all assumes that you have paid off your debts and all that you have are maintenance costs to keep and maintain your home, keep the lights on, and eat each day. Certainly that is the state you should be in before you retire and start living off of your savings. To really be ready for retirement, you should have done the following:

  1. Pay off all credit cards and start using debit cards and cash for everything. You can’t afford to be paying out credit card interest rates.
  2. Pay off your home and any other home equity loans and the like. You need to have the security of having your home free and clear so that it can’t be taken away.
  3. Pay off any car loans. You don’t want to be worrying about a car payment.
  4. Have a good plan for medical expenses, ideally with a back-up plan to Medicare. Hopefully Medicare will remain and help with your medical expenses, but it is good to have a back-up plan just in case benefits get cut, particularly with Medicare Part B plans that are a favorite target for cuts.
  5. Pay off your student loans. These should have gone away before you bought your first house. Don’t go into retirement with loans.
  6. Pay off student loans for kids and grandchildren that are in your name. You can’t afford to be paying off student loans for others while you’re in retirement. Get with your children and grandchildren and discuss how the loans can be paid in full before you enter retirement. Also, resist the urge to take out student loans for children after the age of about fifty-five. As extra incentive, let your children know that you’re coming to live with them should you run out of money.

Note also that this is the minimum amount of savings, and the more you save, the better your life in retirement will be. This is because extra money you have saved – that beyond the minimums – can be invested fully in things like stocks and real estate that will generate more income than the traditional cash-bond-stock portfolio that you would invest in if you just had the minimum. If you have just enough, you’d need to be conservative with your money, and thereby cut your income, because you could not afford to suffer a 40% market downturn as happens every decade or so. If you have extra money, you can have a portion of your portfolio invested in a conservative manner, then have the rest invested in equities and real estate. You can then use the extra income generated by those investments for things like travel and lifestyle.

 

 

 

 

 

 

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.