There are plenty of reasons to be holding cash on the sidelines. Unallocated bonuses, inheritances, selling homes and businesses, exercising options, and pandemic savings are some of the ones we come across frequently. (Though the last one in that list is a relatively recent addition). These funds can represent a problem. Savings accounts are paying next to nothing now but inflation is making sharp moves northward. This is a bad recipe for savers.

Put aside your emergency reserve for a moment. The cash beyond that is doing nothing for you and should be deployed elsewhere. But figuring out where to invest that and when to do it is hard. Odds are you won’t get the perfect mix. Neither will any one of the pros you might hire to help.

The future is uncertain and there is no way to know whether you’re going to stick the landing, so to speak, when you make the leap and redeploy your capital. Success isn’t guaranteed, but there are a few things you can do to improve your chances of a favorable outcome.

 

Wait for a market correction before investing

Wall Street has different terms for the level of bad the market may experience at any given point in time. 10% down is called a correction. Jumping in here with your spare cash can be a good idea. Who doesn’t like a 10% off sale?

One of the obvious drawbacks is that you may have to wait a while for a correction. Markets will probably move higher during that time period. You’ll end up paying more with this strategy if the market climbs 15% before falling 10%. Its tough to know where things are headed and tough to know if this will pay off.

 

Wait for a bear market before investing

A market pullback of at least 20% is called a bear market. These come around a few times a decade. It’s scary when one of these comes up but they aren’t always a harbinger of recession. Mathematically its at least twice as good to buy into a bear market over one that’s just seen a minor correction. This is like seeing the market move from the sale rack to the clearance rack.

Buying into a bear market takes a steady hand and an iron stomach. This is the kind of market where something looks seriously wrong with no clear way to fix it. Putting your money into companies that are at risk of going out of business is not for the faint of heart. But this is the strategy that, when executed correctly, yields the best results. You buy on an extra steep pull back and enjoy the ride back up.

These aren’t common events and you could be waiting years before you see your chance to jump in. Markets could move far higher than 20% over that period. Nevertheless, the odds of this beating an immediate lump-sum investment into the markets is about 21% (based on S&P 500 total return data going back to 1928).

 

Dollar Cost Average into the markets

Dollar cost averaging means you move portions of your funds into the market at regular and predetermined intervals. Your buy-in price will average out as the market ebbs and flows over the interval period you established. Some days you buy in at a high price. Other days you’ll buy at a low price.

If it sounds familiar its probably because this is exactly how your 401(k) works. A fixed portion of your paycheck heads into the market every pay period like clockwork. The benefit here is in the smoothing effect caused by averaging. You’re not required to call it right and time it well like the first two strategies. It can be a weight off your shoulders if you just want a simple “set it and forget it” way to put your spare cash to work.

The historical track record on this strategy isn’t great. Markets generally move higher over time, which means a strategy that averages in over time is likely to sequentially purchase at higher prices. Dollar cost averaging beat an immediate lump-sum investment just 32% of the time when we ran the numbers. That’s not great. It does however provide protection against a sharp and sudden market drop. The peace of mind this strategy provides is powerful and may be worth it to you.

 

Buy all at one time – lump sum purchase

Yup, this is the most successful strategy for putting your funds to work. It beats all other strategies since markets tend to rise over time and pullbacks/corrections are infrequent. But what if you buy in at the wrong time?!?!

That’s known as tail risk. It’s a stats term that refers to the tail ends of a classic bell curve. They represent very low probability events with either disastrous or amazing outcomes. With a lump-sum investment, this would be either a raging, inexorable run upwards or a devastating, near unrecoverable loss immediately after putting your funds into the market. Both of these are possible and both are very low probability events.

You must be willing to accept tail risk with a lump-sum investment. Its an “in for a penny in for a pound strategy”. If dollar cost averaging is slowly working your way down the stairs into a cold pool, then the lump-sum purchase is a cannonball jump with a running start.

 

What Works Best?

Different market conditions call for different strategies.  We generally recommend clients use a combination of these strategies by buying in increments: 1/3 at market, 1/3 at 3% below current prices and the final 1/3 at 5% below current prices. We do this with limit orders. These are orders to buy/sell something at a certain price and only that price.  Limit orders expire after 60 days and can be cancelled at any time, which gives you the flexibility to reassess at any point along the way.

We do not have a crystal ball. Our strategy could be beaten by any strategy you or another advisor create. Like we said earlier, timing all of this perfectly is hard. The pros aren’t any more likely to call it right than you are.

In our opinion, the only clear losing strategy is sitting on excess cash when interest rates are lower than inflation. You need to select a plan that’s customized to your objectives and stick with it, hopefully for decades!

Not sure how to get started? Sign up for our complimentary retirement assessment and we’ll help you get set up and running.

 

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