Lump sum investments
What are lump sum investments? Many people get a lump sum at some point in life, such as receiving a bonus at work or having a tax-free sum from their pension. So how can people put it to good use?
Regarding investing, we will always recommend you seek professional financial advice.
Contents
Bank savings account
Traditional demand-deposit savings accounts offer liquidity and ease of access but pay low-interest rates, and they may also include various fees for handling the account. You can withdraw any or all of the funds in a demand deposit account without penalty or prior notice required. However, they should generally only be used for funds you may need to access at any time, such as your emergency fund.
Funds
Investing in mutual or index fund accounts or exchange-traded funds is a pragmatic approach. A fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the fund are known as its portfolio. Investors buy shares in funds. Such funds have dedicated, expert teams behind them that research individual stocks, enabling you to invest in the stock market at a significantly reduced risk profile. The asset management industry is here to help by offering a multitude of high-quality, short, medium and long-term investment portfolios.
Determining your lump sum strategy
Should you invest it all right away or in smaller increments over time, a strategy known as dollar-cost averaging? Investing in a lump sum comes down to the question of your risk tolerance.
All at once:
Research from Vanguard shows that investors would do best by immediately investing in a lump sum. The simple explanation is that markets tend to go up roughly three out of every four years. Vanguard looked at a 60/40 stock/bond portfolio in the US, UK and Australia. It compared the performance of an immediate lump sum investment over a year against 12 monthly purchases spaced out over a year. The lump sum beats dollar cost averaging about two-thirds of the time and by an average of 1.5% to 2.45%, depending on the country. The results were even more pronounced for longer time horizons.
Investing all of your money at the same time is advantageous because:
- You’ll gain exposure to the markets as soon as possible
- Historical market trends indicate the returns of stocks and bonds exceed returns of cash investments and bonds
- When markets are going up, putting your money to work right away takes full advantage of market growth
Slow and steady
Dollar-cost averaging is a strategy that allows an investor to buy the same dollar amount of investment at regular intervals. The purchases occur regardless of the asset’s price. When a stock or asset is down, think of it as being on sale – your dollar buys more of it – and vice versa.
Dollar-cost averaging is a tool an investor can use to build savings and wealth over a long period. It is also a way for an investor to neutralise short-term volatility in the broader equity market. A perfect example of dollar-cost averaging is its use in 401(k) plans and US retirement savings plans.
Dollar-cost averaging may be for you if you want to:
- Minimise the downside risk of huge investment
- Take advantage of the market’s natural volatility by lowering the average price you pay for shares
- Avoid feelings of regret if the market takes a downturn after you invest
Or wait and see
Delaying investment is a form of market timing, something few investors succeed at.
What to do next
It’s best to work with a financial adviser to make a savings and investment plan to ensure your strategy meets your needs and goals. Together, you’ll consider how your finances stand, what you hope to achieve, how you feel about money and risk, and what might be coming down the track in your life. This gives you the right information to assess and choose secure, suitable, affordable and sustainable investment products.
