Should I invest all at once, or drip feed?

Most of us at some point during our lives are faced with the decision of how to invest a cash lump sum.

We can end up with a lump sum as a result of all sorts of situations, either through years of savings, receiving a bonus, the sale of a house, an inheritance, a pension payout, a divorce settlement, or something else.

Assuming you decide to invest a portion of that lump sum, or even the whole thing, the main question that most people tend to ask is, “Should I invest all at once, or drip feed the cash into the market?”

Before we look at answering the question, let’s first clarify a couple of relevant pieces of jargon. ‘Lump sum investing’ (or LSI) involves investing all your cash immediately. This is in contrast to ‘pound cost averaging’ (PCA), which involves drip feeding your cash into the market over a determined time frame – say, 12 months. Pound Cost Averaging is often called Dollar Cost Averaging (DCA), as most of the work published on the topic comes from the US.

Now, let’s see if we can answer the lump sum investing vs pound cost averaging debate by putting some numbers to it.

What the maths says

Let’s assume you start off with a lump sum at the beginning of the month.

Using historical data for the MSCI World, let’s test 4 scenarios and see how that lump sum would’ve grown under 4 scenarios:

• Investing all at once
• Investing in equal instalments over the next 3 months
• Investing in equal instalments over the next 6 months
• Investing in equal instalments over the next 12 months

It’s traditional to compare investing all at once to investing equally over 12 months, but given that most asset managers drip feed clients’ cash into the market over 3 – 6 months, I thought it’d be interesting to see if it added value.

As for time periods, let’s start by seeing how the different 4 scenarios impact returns over the following 30 years. I’ve also tested the scenarios’ impacts over 1 year, 3 years, 5 years, 10 years, 20 years, and 40 years, and those results are detailed in Section 2.

I’ve taken each 1-month rolling 30 year period from 1969 to 2019 for the MSCI World. i.e. starting with looking at the 30 year returns after investing on 31/12/1969, then taking the 30 year returns from 31/01/1969, and so on. Repeating this for each of the 4 scenarios.

In addition to the MSCI World data, I’ve also tested the 4 scenarios and 7 time periods for the S&P 500, which has data going back to 1926 (but might be less relevant for global investors), the results of which are in Section 3.

Section 1 – The MSCI World over 30 years

If we start with a fictional £100k lump sum, we can then figure out what that £100k would have grown to in each of the 238 rolling 30-year periods for the MSCI World since 1969 across all 4 scenarios. If we then rank each of the 4 scenarios based on the ending value the £100k, we can count how often each scenario ended up giving the best result (i.e. it was the scenario that produced the highest returns over the 30-year period). We can also count how often it was the second-best result, third best, and worst.

The following 4 charts show how often each scenario was the best/second best/third best/worst choice for investing your £100k:

Clearly the numbers show that investing immediately has been the best idea the majority of the time. It was the best option 56% of the time, and the worst option only 16% of the time. But it’s also interesting to see how that as you lengthen the time period over which you pound cost averaged, the less often it was that it was the best option, and the more often it was that it was the worst option. Investing once a month over 12 months ended up being the best option only 19% of the time and the worst option 63% of the time.

If we take the traditional approach and compare only 2 scenarios – scenario 1 and scenario 4 (invest immediately vs invest over 12 months), then investing immediately comes out ahead 74% of the time.

These approaches give you an idea of which scenarios come out ahead. But by how much does the best scenario beat the second best? By how much does it beat the worst? Let’s put some monetary values in to quantify the differences:

The first thing you notice from the results is how often investing all at once comes out ahead. Investing immediately produced the highest average portfolio value after 30 years, turning £100k into around £2m (measured using both mean and median), it had the best worst-case outcome, and the best best-case outcome. On the other hand, it also had a slightly higher standard deviation, meaning there was a little more dispersion in distribution of results than pound cost averaging over 12 months.

But I think one of the most striking things from the data is how similar all the results are.

The difference between investing all at once and investing over 12 months was only about £100k when looking at both the mean and the median, which works out at only a 5% difference between the 2.

If you have a time horizon of 30 years, whether you invest your cash all at once or drip feed it in over the next year, it doesn’t make much of a difference. As we saw in this post, your time horizon can save you even if you invest right before a huge market crash.

This, I think, is one of the major problems of thinking about the decision of whether to pound cost average or not in a binary ‘LSI beats PCA’ sense. It ignores any sense of the magnitude of how much one strategy beat the other by. Hearing ‘LSI beats PCA 75% of the time’ ignores whether PCA was only slightly worse in terms of returns (so perhaps meaning PCA’s non-returns-based advantages make PCA the preferable option), or whether PCA was crushed every time by LSI.

It turns out, if you have a long enough time horizon, whether to PCA or not doesn’t really matter for your long-term returns.

Section 2: Other time periods

Now we’ve looked at the MSCI’s returns over a 30-year period, let’s see how our 4 scenarios fare over 1 year, 3 years, 5 years, 10 years, 20 years, and 40 years. 

(It should be noted that as the length of time for analysis increases, the number of periods for analysis decreases. For example, there are 586 rolling 1-year periods, but only 118 rolling 40 year periods.)

Starting off with the traditional approach, where lump sum investing is compared to pound cost averaging over 12m (comparing only scenario 1 to scenario 4), LSI beats PCA between 61% and 75% of the time.

Regardless of the time period, LSI has beaten PCA by a heavy margin. It’s interesting to note that the roughly 75% of the time LSI beats PCA is similar to the statistic that markets have risen in roughly 75% of years. It’s the fact the market rise most of the time which has resulted in lump sum investing being the best option most of the time, as it means that pound cost averaging results in paying higher prices each time you invest.

If we now extend this analysis and look at all 4 of our scenarios over the additional time periods, we can see what percentage of the time each scenario was the best choice:

As we saw with our previous results, investing all at once was the best option out of the four the majority of the time, and the result was consistent across all time periods.

If we now quantify the differences in terminal values over the different time periods, we get the following results:

As we saw with the 30-year analysis, investing all at once comes out ahead, on average, over almost every time period. Over longer time periods, LSI has better best-case and better worst-case scenarios than any form of pound cost averaging.

But again, we can see how similar results are. The differences in average terminal values over 40 years are pretty small, and even the differences in best- and worst-case scenarios are surprisingly minor.

Turning away from only looking at returns, the results below show the standard deviation of each of the 4 scenarios over the 7 different time periods:

At first glance, it’s clear that investing over 12 months provides the most consistent returns. But that consistency is much greater over 1 year, and decreases as the time period increases.

Over the extremely short term, say 1 year, PCA seems to be preferable if you’re worried about losing capital. The standard deviation is much lower over a year if you PCA, and decreases the longer the period is that you PCA over – i.e. pound cost averaging over 12 months had less dispersion than if you pound cost averaged over 3 months (which makes sense, because the longer you’re averaging over, the longer you’re not investing and thus preserving your capital).

This is true over longer periods, but the effect is most pronounced over 1 – 5 years. The difference between standard deviations is much larger over 1 year than over 40, meaning that even if you PCA over 12 months, your long-term returns will still be subject to a huge amount of variance – just as if you’d invested all at once.  

So over the short term, pound cost averaging comes out ahead for reducing dispersion, but it comes at a cost and ultimately doesn’t affect the dispersion of your returns a huge amount in the long term. In terms of the likelihood of maximising returns, LSI still comes out ahead of PCA over the short, medium, and long term, most of the time.

Section 3: Testing our scenarios on the S&P

 The MSCI World is likely the best benchmark to use for global equity investors, but the trouble with MSCI World data is that there isn’t that much of it. Returns only go back to the end of 1969.

Using S&P data gives us an extra 40 years worth of data going back to 1929 which we can play with (all data courtesy of the Ken French data library).

Running the same tests as above, the results were as follows:

Interestingly, despite an extra 40 years of data in a single country’s market, the results are almost identical to those of the MSCI World:

• 75% of the time, LSI beat PCA (where PCA was defined as investing over 12m)
• Comparing against the other 3 scenarios, LSI came out as the best option over 50% of the time over all time periods
• On average, LSI came out ahead of the other 3 scenarios for terminal value over all time periods
• But in the long run, the differences between LSI and PCA were relatively small
• While the worst outcome was mixed, LSI also had the best best-case outcome over all time periods
• Pound cost averaging over 12 months was the safest bet for minimising dispersion over one year, but made little difference to dispersion over the longer term

Section 4: Why would you ever PCA?

We know that most of the time, LSI comes out ahead of PCA when looking at returns.

But what about those times where PCA beat LSI? Why did PCA outperform?

Intuitively, you’d think that if the return was negative over the year in which you pound cost averaged over, then PCA would come out ahead.

Looking at the data, we can see that in the months where the following 1-year return was negative, 77% of the time pound cost averaging over 12 months beat lump sum investing. And in 85% of months where the following 6-month return was negative, PCA beat LSI.

So if you’re worried (or confident) that the market’s going to fall over the next 6 months to a year, then pound cost averaging is very likely to come out ahead.

This makes sense, as by pound cost averaging through a falling market, you’re essentially buying the market at cheaper prices every month over the next year before the market eventually starts to rise again.

But if you look at the annualised returns over 30 years, it actually doesn’t make much difference whether you PCA or LSI if the market falls over the next year. If you look at all the periods where the market fell in the next 12 months, the average return you would’ve made if you pound cost averaged over the period would’ve been 11.15%. That’s compared to 10.84% if you knew the market would fall, and just invested anyway.

It goes without saying that it’s impossible to predict when the market’s going to fall. Not even the experts can do it reliably, and being unable to forecast the market’s direction is one of the major reasons that passive investments have outperformed almost all active ones.

But even if you know ahead of time that the market will fall in the next 12 months, over the long run it didn’t make a huge difference whether you used LSI or PCA.  

Why else would you PCA?

It’s pretty clear by now that pound cost averaging isn’t the best idea for maximising returns. But it does have other advantages.

Getting invested. Some investors find the markets a scary prospect. If dipping your toe into the water every month helps you get invested, then that’s a great thing. Especially as we’ve seen that over the long term, the returns aren’t too much lower than investing right away.

Avoids 100% in/out. Pound cost averaging helps avoid the temptation to market time with all your cash. Whilst pound cost averaging is technically a form of market timing, it’s definitely preferable for investors to systematically market time by investing once a month than to try and market time using all their cash, based on when they think they can pick the bottom of the market. 

Peace of mind. Ultimately, the aim of investing is to give us the peace of mind that we’ll have enough cash to achieve whatever our objective is (retiring, sending children to university, passing on wealth). So if pound cost averaging helps you minimise stress and stops you from staying up late at worrying about the fact you’ve just invested your whole lump sum and the markets might crash, then it’s a great option. Especially given that there’s always a reason to worry that the market might crash.

Minimises regret. Investing at the wrong time can feel pretty terrible, especially if you invest everything at the wrong moment. Pound cost averaging helps reduce the chance that the market falls right after you invest, and so reduces the chance you regret investing. This is especially important, as any feelings of regret might either put you off investing in the future, or cause you to try to recoup the losses in your portfolio by altering its contents. After all, it’s said that your portfolio is like a bar of soap – the more you touch it, the smaller it gets.

Conclusion

• When looking at future returns, out of our 4 scenarios over a 30-year timeframe, investing all at once was the best option 56% of the time, and the worst option only 16% of the time. Investing once a month over 12 months ended up being the best option only 19% of the time and the worst option 63% of the time.

• The main reason for LSI coming out ahead of PCA is simply that markets go up most of the time.

• Having said that, when quantifying the differences between LSI and PCA over 30 years, the returns for PCA were very similar to those from LSI. If you have a long time horizon, it doesn’t make much of a difference whether you invest your cash all at once or drip feed it in over the next year – even if you invest it all right before a crash. There will likely be other financial/investment choices you’ll have to make that’ll have a larger impact on your long-term returns.

• Looking at different time periods, even over 1 year, 3 years, 5 years, 10 years, 20 years, and 40 years, investing all at once comes out ahead, on average, over almost every time period. But again, the differences in average terminal values over 40 years are surprisingly small.

• PCA does come out ahead if the market falls over the year you’re averaging in, but:
  • • It’s impossible to know whether the market will fall in the next 12m,
    • The difference in returns between PCA and LSI even when the market falls is small, on average.

• Over the short term, pound cost averaging reduces dispersion, but it comes at a cost and ultimately doesn’t affect the dispersion of your returns a huge amount in the long term. Even if you PCA over 12 months, your long-term returns will still be subject to a huge amount of variance – just as if you’d invested all at once.

• These findings are almost exactly the same when looking at data from the S&P 500, across all the same time periods.

• Depending on the type of investor you are, PCA can also help you get invested, avoid risky market timing, sleep better, and minimise regret.

• Overall, if you’re only concerned with maximising returns, then LSI is statistically the best way to go. But behaviourally, PCA can be a very good idea. If you’re worried about markets over the next 12 months (or just want to hedge against the possibility of a market fall), if you find easing into the market easier to stomach, if you’d sleep better by pound cost averaging, or if averaging would help you deal with the regret of investing before a market crash, then it can be a great way to invest. Especially because, in the long term, the results aren’t too dissimilar to lump sum investing anyway.

The next post in the series introduces the concept of diversification, looking at what it is, and why we need it.