When Should You Invest Your Million

Let’s say you have recently received $1,000,000 unexpectedly that you have somehow determined should be invested in the stock market for the long-term.

When should you invest it? Should it all go in as soon as you get it [lump sum] or should you space it out over 6-12 months [dollar-cost averaging]?

This is a classic behavioral finance question, and of course it would be easy if you knew where the market was headed, but since we don’t, things quickly get messy.

The industry answer is what I call the Spreadsheet Answer. The argument goes like this: because historically the market goes up, you should invest it all as soon as you have it. Every day you sit on cash, you are losing out on the opportunity [or potential] for the higher returns. This assumes that you plan on leaving the money invested for a very long time and that you are the rare individual that calmly makes rational decisions based on Spreadsheet Answers.

The second and far more reasonable way to look at it is the Sleep-Factor Answer. It is time that we realize unless you see Warren Buffet in the mirror, emotions play a much larger role than we care to admit. We are not rational beings that can live with Spreadsheet Answers. In the real world, real people do not make rational decisions all the time. We feel real pain and fear when we see large declines in our investments. If you recognize that reality, it makes managing your behavior a much more important factor in this decision.

Think about this for a minute: you are sitting there with $1,000,000! Now you have to decide not only how to invest it, you have to decide when…

The risk with investing it all now is that when you face the first decline it will be far more difficult than you think to stay the course. With buy and hold investing, it is not the buy part that is hard, it is the hold. Experience has proven that most of us just want out when things get scary. This is an emotional issue, and throwing more facts at emotion does not work. So to argue that the stock market historically goes up over long periods of time…blah, blah, blah….When you invested $1,000,000, opened your statement, and you have $800,000, all you know is that it is causing you pain and you want the pain to stop.

I am not saying it is smart, but I am saying it normal. Since it is normal, we should plan on it. If we plan on it, we would ease into the market over a period of months to minimize the chance of making the big behavior mistake of buying high and selling low.

[This post was inspired by a question that I addressed for The New York Times.]

By Carl on 11.04.09 > Link

Tagged as: New York Times, sleep-factor answer, spreadsheet answer

  • briansb
    @ RobBennett: I don't disagree with you, but this is the Spreadsheet Answer Carl refers to. Most individual investors don't think or behave according to rigid systems.

    I'm a strong advocate of dollar-cost averaging regardless of what the market it doing on a given day. Knowing that realized losses (whether only as reported on a statement or because of a panic sale) carry much more emotional weight than foregone gains, a DCA approach provides a much better Sleep-Factor Answer. That comfort level promotes long-term investing.
  • Adam S
    Dollar cost averaging into the market for me. I wouldn't invest in an index fund and would look to individual stocks, bonds, cash accounts etc with good long term prospects. In other words, exactly how I have actually done it with my own money in the last decade. It's worked pretty well over the years.
  • Ann
    I fully funded my Roth IRA in one fell swoop last year in July, all 5K of it. I thought about doing something other than putting it all in at once, but was eager to be done with it.
    Now I wish I'd waited. I could've bought a lot more shares if I had.
    But at least I'm learning my lesson this year. Between my 401(k)-which I'm investing $ in this year because of the low stock prices-and my Roth, I'm investing every week.
  • I think this video from Kenneth French does a great job of answering the question: http://www.dimensional.com/famafrench/2009/06/d... :)
  • it would be easy if you knew where the market was headed, but since we don’t, things quickly get messy.

    As you know from my earlier comments, I do not buy into this premise.

    It is of course so that we do not know where the market is headed if we fail to take price into consideration when setting our stock allocations (Passive Investing). If we are willing to take price into consideration (Rational Investing), long-term returns are highly predictable (the historical data shows that the return obtained at 20 years is 78 percent predictable for those willing to look at the P/E10 value that applies on the day the stock purchase is made).

    So my answer is -- if stocks were selling at a price at which a good long-term result was a high probability, I would put the money into stocks immediately. But if stocks were selling at a price at which a good long-term result was a low probability, I would put the money into something where it would hold its value until stocks were again selling at a price at which a good long-term result was a high probability.

    I very much agree that the "hold" part is the hard part of a buy-and-hold strategy. I do not think it is possible for buy-and-hold to work for Passive Investors (investors who refuse to change their allocations in response to big price changes). The problem is that investors can never possess inner confidence in a strategy that requires that they ignore price. We all know from buying thousands of things other than stocks that price matters and it is impossible for us to believe on a deep level that this common-sense rule does not apply with purchases of stocks too.

    However, I do think that buy-and-hold can work for valuation-informed investors. There are times when market prices are irrational. Those times can go on for 10 years or even a bit longer than that (stocks were selling at insanely inflated prices from January 1996 through September 2008). But so long as the investor understands the effect that valuations have always had on long-term returns, he knows that these periods of irrationality are a temporary phenomenon.

    Passive Investors were shocked by the price crash. Rational Investors saw it coming back in 1996. Price crashes do not cause emotional stress for those who understand what causes them and who protect themselves by making the necessary adjustments to their stock allocations.

    Rob
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