Staggering Investments: Forgoing Returns for a Good Night's Sleep

Have you sold your house? Made an inheritance? Or cashed out your pension fund? Then you are probably thinking about how best to invest your capital. And not only how – but also when: Does it make sense to make a large one-time investment or rather to spread the funds over several small payments?

In such cases, the conservative investment strategy recommended time and again is not to invest a large amount all at once. Instead, it should be invested gradually over time. This sounds good in principle.

After all, with a one-time investment there is the risk that the financial markets are at a peak right now and that prices will fall in the near future (Even though it is just as likely that prices may rise in the next few months).

So is it worth staggering your investments?

Market timing in disguise

This is the wrong question to begin with.

A well-diversified portfolio has always beaten attempts to predict the right time to enter and exit the market over the long term. Any money that you won't need for the next ten years should therefore be fully invested as soon as possible. And you should start as early as you can. It is best to invest everything in one go, but in such a way that you can stick to your strategy even after market downturns.

Everything else is market timing.

For the few of us capable of doing it, it makes sense. But the vast majority of short-term thinking day traders are not successful and soon give up. Even professionals with a medium-term horizon are no better with their forecasts. Statistically speaking, trying to time the market is detrimental to returns.

Helps against pain

Psychologically, however, it makes perfect sense to stagger investments. Everyone has their own pain threshold. Many investors already panic when an investment of 100'000 francs loses 20 percent. But maybe you are one of those hardy people who can bear a halving of an investment of 100'000 francs in the short term?

Whether 20 percent or 50 percent: Every loss hurts. And even if, in retrospect, markets have usually made up for setbacks after ten years at the latest – are you steadfast enough to wait this time out? (We have dealt with loss tolerance in detail in another article. You will find the link to it at the end of this article).

A setback on capital that they have previously gained is easier to bear for most investors – as long as the originally invested sum remains unscathed. However, it feels particularly painful when a loss occurs immediately after the investment was made. Because then the loss not only affects past gains, but also the amount you have paid in.

So if you fear a correction in the near future, you can ensure a calmer sleep by spreading your investment over time. Even if – according to all experience – you will forgo returns by taking such a decision.

How to spread your investment over time?

If you decide to invest your capital gradually, you are basically acting like someone who is first building up their assets. You plan how much you want to invest, how often you will do it and over what period of time.

For example, you could divide your assets into 36 equal instalments and invest the same amount every month over the next three years. Or 60 equal instalments over the next five years. Or even twelve instalments every quarter over the next three years. Whatever suits you best. Conveniently and automatically using a standing order.

Averaging costs provides diversification

If you regularly invest smaller amounts according to such a plan, you benefit from cost averaging.

Each time, you buy shares in an ETF with a fixed amount. When prices are high, you buy fewer shares – and when prices are low, you buy more. Over a longer period of time, an average price is formed.

However, the cost-average effect only has a measurable impact on short- and medium-term investments. The longer your investment plan runs, the smaller the effect. This is because each individual transaction has less and less influence on the average price at which the units are acquired.

Cost averaging is great. Especially for those who are starting to build up their wealth. We have shown that it is better to invest regularly and not skip any instalments even after losses (See the link at the end of this article).

Is cost averaging enough to diversify your portfolio?

At first glance, staggering investments also achieves portfolio diversification. This is because when investing in different asset classes, more shares are automatically bought in those ETFs where prices are low. When prices are high, the investor buys a smaller number.

In the long run, however, staggering investments does not lead to a better diversification of the portfolio. The shares of the different asset classes shift with the price fluctuations. An investment that is supposed to make up only 20 percent of the portfolio can quickly reach a share of 30 percent or more when prices rise.

For this reason, relying solely on cost averaging does not achieve sound diversification. Over the long term, it is imperative to rebalance your portfolio. You can read more here about how we do rebalancing for our clients at True Wealth and why it matters for a diversified portfolio.

Rebalancing is better than staggering

Rebalancing not only provides good diversification in the long run. It also achieves precisely what many expect from staggering their investments.

What if you not only fear a correction of the stock market, but also see it as an opportunity? Then it would make sense to only invest part of your money. You should also have cash up your sleeve – and be able to buy shares after prices have dropped.

This is exactly what happens automatically in a well-diversified portfolio: After setbacks on the stock market, the share of stocks in the portfolio becomes smaller, while bonds grow. By rebalancing the portfolio, shares are bought precisely when they are particularly cheap.

If your portfolio is being managed by True Wealth, rebalancing occurs automatically, without you having to do anything and at no extra cost to you. This is because all transaction costs are included in our management fee.

Links

• Drawdown: How Much Can You Afford To Lose?
• Rebalancing: An Extra Half Percent

An earlier version of this article was published on the 08.03.2018.

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