Diversifying Across Time

“Diversify across securities, across asset classes, across markets – and across time.” – Charley Ellis

Reader emailbag: I have been saving for a number of years and have a large cash balance that I would like to invest in the market.  Should I spread my purchases out or wait for the market to fall and invest all at once?

I have received a number of variations on this type of question over the past month or so. Many readers have shared with me that they’ve built large cash balances and for a number of reasons have not invested in the stock market for the past few years.

As we’ve continued to power through new highs in the market this has only added to the nervousness of those in the position of holding cash in a rising market.

I’m a fan of dollar cost averaging for investors.  It’s a simple solution and it solves a host of behavioral issues.

I’ve read the academic research papers on the subject and they all show that roughly 70% of the time it is mathematically more advantageous to invest a lump sum as opposed to averaging in over time.

I could have saved the researchers of these studies some time and excel spreadsheets by pointing out the fact that the stock market has historically risen around 70% of the time on an annual basis.

But financial decisions are not always guided by quantitative factors. There are qualitative factors and risk controls to think of as well.

Just as it’s prudent to diversify your investments over a wide range of geographies, markets and holdings because it’s difficult to predict which ones will do the best over specific time frames, it also makes sense to diversify over time through periodic investments.

I had some peers in the investment industry telling me during the crash that they were personally only making new contributions in their retirement plans to money market funds until they could see how things would shake out.

This made no sense to me.

While it wasn’t easy to continue to invest in stocks every couple of weeks when it seemed like all they did was go down, my guiding principle was the fact that it didn’t matter to me if they continued to fall another 10-20% in short order.

I knew that I was unlikely to see prices that low ever again and my 40+ year time horizon meant I was very likely to see much higher prices over time.

Obviously, we are at a much different point in the cycle right now.  But stocks don’t have to correct because they should.  And the longer you wait to invest the harder it will be to pull the trigger.

I feel for those investors that got left behind from this market recovery. There are a number of reasons investors missed out on the run up in stocks — bad advice, a misunderstanding of market history, fear of another crash from the recency effect or just a lack of knowledge on markets in general.

Whatever the case may be, the past is the past, and what matters is where you go from here.

My advice would be to break up your cash into equal pieces and invest periodically (bi-weekly, monthly or quarterly should work) into your designated asset allocation weights over the next year or so. Make the purchases automatic so you don’t get tempted to make changes to your plan.

If the market does have a meaningful correction then you can feel free to increase your contributions.  Once fully invested at your pre-determined asset allocation, follow your long-term plan and try not to deviate based on fluctuations in the market.

Daniel Kahneman once said that, “All of us would be better investors if we just made fewer decisions.”

He’s not saying that you should be lazy and avoid making choices altogether. Kahneman is telling us to make good decisions ahead of time to avoid trying to nit-pick every move in the markets.  That’s a game most are ill-suited for because of time or knowledge constraints or behavioral deficiencies.

Automating good behavior is one of the best ways to reduce the number of decisions you have to make and improve your overall performance by getting out of your own way. It takes over-thinking and second-guessing out of the equation.

If you have to constantly determine the perfect moment to invest your money you will be subjecting yourself to paralysis-by-analysis. There will always be a better time to invest down the road once that correction you’ve been waiting for finally hits.

Dollar cost averaging takes the responsibility of poor timing decisions out of your hands. It’s not the perfect solution, but it helps you move from short-term guessing to long-term planning.