How to Invest A Lump Sum of Money

"Should I stagger my investments or invest a lump sum of money?"

Many investors know the concept and benefits of dollar-cost averaging or investing a regular amount. It’s commonly understood that the best results come from regular savings that reduce the average cost of purchase.

But what about when you are changing your investment strategy or want to invest a cash lump sum? Are the rules different? Should you dive in or go step-by-step?

Let's discuss.

As with most things, it depends on first, you and your circumstances; second, the cost; and third and most of all, your head. Or your emotions to be specific.

To some people, $10,000 to a diversified fund is a flutter and to others, it’s hard-earned scrimping and saving. It’s all relative to you, how experienced with investing you are and often the source of the money.

Money from a great lotto ticket or recent investment gains is somehow different than money from inheritances or regular accumulation.

This is what’s called “mental accounting” coined by Noble Prize winner Richard Thaler, who wrote this great book.

Think of the mental part in an Urban Dictionary sense rather than cognitive, because it ain't rational.

So whilst there’s no hard or fast rule as to whether an amount is meaningful, it is your first point to consider.

Your second consideration is slightly more mundane – but nevertheless important. There are often minimum investment amounts or transaction fees that prevent drip-feeding.

With Kernel that’s irrelevant as there are no transaction fees whether you invest weekly, monthly or all at once.

Once you’ve found a cost effective solution, you do need to consider the effort involved. You want to avoid manual action on your part if possible because things always get.in.the.way.

It’s life – you’re busy, things pop up. Finding an auto-invest really is a must if you want to drip feed your investment.

The last, and most important consideration, is the level of emotional protection you need. Our general advice is by all means invest your lump sum at once, because time in the market is ultimately your greatest friend.

But, if you do this, you have to promise us that in two weeks, four weeks or 12 weeks from now, you won’t freak out if the market goes down and change your investments.

Over the long term, you’re very, very unlikely to lose all your money invested in a diversified fund. However, it will bounce around and this can happen the day after you invest.

No one likes to see their $10,000 suddenly become $9,865.

All those endorphins you had after investing your money towards your goals suddenly become a kick in the guts.

This is because of two pretty powerful psychological concepts:

• loss aversion and

• dissonance.

What is loss aversion?

Loss aversion, or officially “prospect theory”, is that losing money hurts so much more than gaining money. Call it reptilian, competitive or self-protecting; it’s been proven over and over again that we hate losing about twice as much as winning. My 4 year old’s tantrums are a testament to that!

And money is so emotional – it’s our belief in the future and our prosperity.

What is dissonance?

Also known as buyer’s remorse. This is the disharmony, discomfort, tension, shame and anxiety that comes after a purchase. It applies to that amazing patterned but expensive shirt that caught your eye, as much as to the investment that you chose.

If only you’d waited a month – the shirt was on sale or you’d have avoided the market dropping 15%.

Hindsight is so wonderful. Yet not even the experts can predict the future or avoid it.

This is where staggering your investment over some weeks or months gives you emotional protection. When investing for the long term you’ve got to remember it’s long term.

You can’t change your mind if it goes wrong to start with or chase the recent good returns of other investments.

Only true changes in your personal circumstances should result in a change to your portfolio.

Promise?

If you’re in a great position to be investing a lump sum and a regular amount from cash flow – good news – you can do both simultaneously.

Say you have $20,000 plus $1,000 a month to invest, yet you want to spread your $20k over a few weeks to dollar cost average.

Investing over 10 weeks means you start your weekly investments at $3,000 ($20,000/10 + $1000) and then once your lump sum is fully invested, you reduce your regular amount to $1,000.

Too easy.

The principles of investment timing remain constant, regardless of market conditions. So you're better off asking yourself what strategy enables you to get to the outcome you want without the huge amount of stress.

Consider investing the full lump sum if:

• You have exceptional emotional discipline

• You can maintain a genuine long-term perspective

• You can resist reactive selling during market fluctuations

• You understand this approach typically yields better returns over the long term

• You can make an unwavering commitment to your investment plan

Consider spreading your investments over time if:

• You want to manage your emotional responses to market movements

• You prefer the security of regular, smaller investments

• You're concerned about market timing

• You want to reduce the impact of market volatility

Remember - whichever strategy you choose requires an unwavering commitment to your investment plan, regardless of short-term market movements.

Can you make that promise?