Long before actor Matt LeBlanc played Joey on Friends and even before he appeared as Kelly’s boyfriend on Married…With Children, he was pitching Heinz ketchup. In the mid-to-late 1980s, Heinz produced a series of ads and commercials persuading consumers that “the best things come to those who wait.” Joey, err Matt, appears on the roof of a brownstone with a bottle of ketchup. He twists off the cap, lays the bottle on the ledge, and casually make his way down the stairs. At ground level is a hot dog stand with several people in line. The essence of late 80s cool, Matt buys his hot dog and holds it behind his back, just in time for the free-falling ketchup to land perfectly on the dog.
Ironically, this ad was geared toward our impatient society 30 years ago. Today, Americans don’t have time to wait for anything, especially ketchup, which is why we’ve moved on to plastic squeeze bottles that deliver instant gratification.
Despite our society being impatient, one area where people often hesitate and are too patient is in putting money to work in the stock market. Say you have a large amount of money (retirement rollover, inheritance, idle cash) that needs to be invested but you’re nervous about markets being at all-time highs. What’s the best way to put this money to work: all at once or over a period of time?
We’ll call the “all at once” method the lump sum approach, which involves picking a mix of stocks and bonds (asset allocation), for example, 60% stocks and 40% bonds (60/40). The other approach is commonly known as dollar-cost averaging, which means investing a certain amount of cash in the markets on a regular basis. For example, you have $250,000 that needs to be invested. One way to dollar-cost average would be to invest $25k per month for 10 months.
Mutual fund giant Vanguard did a study a few years ago that sought to decide once and for all which strategy works better. The results may surprise you because they seem counterintuitive. One would think the go-slow approach would take advantage of any ups and downs in the market by buying less when the market is up and more when the market is down.
In actuality, lump sum investing beats dollar-cost averaging roughly two-thirds of the time over rolling 12-month periods going back to 1926. For a 60/40 allocation, investing a lump sum immediately has outperformed dollar-cost averaging 68% of the time. This relationship holds true across a wide range of asset allocations, from conservative to aggressive, as well as over various dollar-cost averaging periods (putting money to work over 1 year vs 3 years, for example).
To be a successful investor, you need to have long-term patience. You must stick with an investment plan and let time and compound interest do their thing. But when it comes to putting money to work, history has shown more often than not it’s better to do so as a lump sum rather than to tip-toe into the markets.