Be systematic in investing, not impulsive

If you have received a bonus or have saved a small sum and are looking at how to invest, you may be wondering whether to put it into the market all at once or to average out your costs with regular monthly investments.

Even though investing a lump sum may deliver better returns, investing smaller amounts regularly and keeping it invested can be an effective strategy.

INVESTING A LUMP SUM

With slower economic growth, exacerbated now by the Covid-19 outbreak, investing the money you have saved all at once may seem risky.

Many advisers tout the benefits of “dollar-cost averaging” through regular monthly investments instead, and it can sound attractive. 

Averaging out the highs and lows in the market with regular monthly investments allows for dollar-cost averaging, which seems like it may reduce risk and provide better returns. Since there is no way to know whether stocks or bonds are at a low or will go down further, regular monthly investments seem to allow you to buy at a range of different prices that average out to be attractive.   

While that practice sounds appealing and less risky, research shows that it does not generate the best financial returns.

Investment research firm Morningstar said that academic and practitioner research has rather unambiguously come down on the side of rejecting dollar-cost averaging as a superior investment approach, compared to lump-sum investing. 

Associate Professor David Cho and Assistant Professor Emre Kuvvet of Nova Southeastern University in the United States did a review of a broad range of studies over the past three decades and similarly found that dollar-cost averaging is inferior to lump-sum investing and other investment techniques.

Research in Australia and the US by investment management firm Vanguard showed that immediate investment of a lump sum outperformed dollar-cost averaging about 64 per cent of the time over a period of six months and 92 per cent of the time over 36 months.

Moreover, immediate investment outperformed dollar-cost averaging by 2.3 percentage points in the US and 1.4 percentage points in Australia.

A key reason that investing all of your money at once is better is that it lets you take full advantage of market growth when markets are going up.    

REGULAR MONTHLY INVESTMENTS

While research shows that investing a lump sum may be better, the better course for many investors may be, counterintuitively, to make regular monthly investments.

As Professor Meir Statman of Santa Clara University in the US explains it, a fear of loss can deter investors from buying stocks altogether.

Loss aversion is a well-documented part of how behavioural economics describes investors making choices among alternatives, he says.

While dollar-cost averaging may not result in the best returns, it overcomes the inertia of loss aversion and keeps investors in the market. 

Professor Karyl Leggio of Loyola University Maryland in the US similarly told Yahoo Finance that the value of dollar-cost averaging is the discipline of continually putting money into the market.

“The reality is you aren’t able to time the market. Over time, you miss more opportunities than you save by trying to time the market,” she said.   

A benefit of regular investments, Vanguard notes, is that they allow you to minimise the risk of a huge investment all at once. You can take advantage of the market's natural volatility by lowering the average price you pay for shares and avoid feelings of regret if the market takes a downturn after you invest, 

Moreover, regular investments fit the style of investors in Singapore.

Research by investment management firm Schroders found that investors here are more likely than investors in other countries to have a bias towards safer and more predictable investments. 

Although the expected return is lower for dollar-cost averaging than for lump-sum investing, professors Cho and Kuvvet also said that the risk was smaller for dollar-cost averaging compared to lump-sum investing.

Reinforcing how dollar-cost averaging can benefit investors, investment advisory firm Nerdwallet said that dollar-cost averaging saves investors from their psychological biases. Because investors swing between fear and greed, they are prone to making emotional trading decisions as the market gyrates.

While you may forgo gains that you otherwise would have earned if you had invested in a lump-sum purchase and the stock rises, the success of that large purchase relies on timing the market correctly and investors are notoriously terrible at predicting short-term movement of a stock or the market.

What is important, too, is to keep making regular investments and not to pull money out if there is a downturn.

Recent research by automated investment firm Stashaway found that “systematic investors” — those who invest at least quarterly regardless of market movements or media noise and stick to their investment plan — made about 10.8 per cent over the past several years, despite market corrections.

Impulsive investors who pulled their money out during a market correction, on the other hand, averaged losses of about 2.2 per cent.  

While making regular investments may not provide absolutely the best return, it has a multitude of advantages for many investors. By ensuring that you really do invest, rather than waiting for exactly the right time and potentially putting off investing altogether, you will be on far sounder financial footing.