Rick's Rules for Lump Sum Investing

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Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Thu Dec 01, 2011 10:10 am

What do you do with a lump sum?

Lump sums can come from several different sources — a pension payout, inheritance, the sale of property or a business, or perhaps winning the lottery. Here are a few simple rules, or guidelines if you prefer, to help decide on a dollar-cost average or all-in strategy:

4 Rules for Investing a Lump Sum

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Re: Rick's Rules for Lump Sum Investing

Post by FredPeterson » Thu Dec 01, 2011 10:46 am

...My rule of thumb is 20 percent. If a lump sum is 20 percent or less of the amount you have already saved...
By 'saved' do you mean all savings including bank assets and investment accounts including tax deferred/free or ?

Can you elaborate on the 20% figure and how you decided on it?

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Re: Rick's Rules for Lump Sum Investing

Post by Don Christy » Thu Dec 01, 2011 11:30 am

Rick,

I'm surprised at the emphasis you place on where the lump sum comes from. I actually thought your two final points on whether to revisit your IPS were much more useful than the 4 rules. I would think your current AA and any resultant revision of IPS/AA related to the size of the lump sum would dominate the decision of how quickly to "invest." I put quotes around invest because ultimately it's all invested whether in CDs, MMFs, or under the mattress.

Neglecting behavioral/psychological reasons, delaying deploying all your assets per an appropriate AA just increases the risk of not achieving the goals of your IPS. IMO DCA only makes sense in the context of regular savings, not as some form of risk management strategy of timing or averaging the deployment of current assets. I would argue the latter only serves psychological purposes.

Question for Rick: do you really believe there is any benefit, beyond psychological, to average from lump sum cash into your appropriate AA as determined by your IPS instead of immediately deploying your assets per your IPS?

As I think more about your rules, and your emphasis on where the funds came from, I think these are really just proxies for taking into account current AA, i.e. you assume the source of funds implies a pre-lump AA and basically seek to maintain that AA, albeit not immediately.

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Re: Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Thu Dec 01, 2011 1:49 pm

By 'saved' do you mean all savings including bank assets and investment accounts including tax deferred/free or ?
Your investment capital that is under some sort of investment plan. I do not mean cash in the bank for spending needs.
Can you elaborate on the 20% figure and how you decided on it?
A 20% lump sum is not a material amount of your net worth. There is no reason to fret over how to invest this money. Jut put it in. You can use 25%, 50%, or whatever is right for you.
Question for Rick: do you really believe there is any benefit, beyond psychological, to average from lump sum cash into your appropriate AA as determined by your IPS instead of immediately deploying your assets per your IPS?
The difference between all-in and DCA is really a question of comfort. From a purely technical aspect, a majority of the time you'll come out further ahead by putting it all in all at once, and this includes cash and securities.

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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Thu Dec 01, 2011 6:22 pm

Rick,

From your Rules:
Was the money inherited, won, or from another source where you had no previous ownership? Here is where DCA works well. I recommend investing 40 percent now and DCA the other 60 percent over the next 3 years. For example, imagine you won $1,000,000 after tax in a lottery. Invest $400,000 this year and $200,000 per year for the next 3 years. This spreads out your entry-point risk.
Why does DCA "work well" here? How did you arrive at the 40/60 percent rule? What is "entry-point risk"?

I think it's actually simpler than you say. Assume an investor with an established Asset Allocation (AA) and diversified investments now has a lump sum to invest.

1. Is the lump sum actually not "new" money, in that it was part of the existing AA? For example, some bonds mature. Then, simply invest it, all at once, back into the AA.

2. Is the lump sum "new" money, like an inheritance or lottery windfall? Then,
a. Is the amount large enough that it causes the investor to change their desired AA*? Decide what the AA going forward should be.
b. Invest the lump sum, all at once, into the desired AA, rebalancing other investment assets as required.

* A simple example. I "need" $100,000 per year to retire, I anticipate $20,000 from Social Security. I have $1m in investments which, at 4%, will yield me $40,000 in retirement income. So, my AA is fairly aggressive, since I need to double my investments before I retire. Tomorrow, I receive a $1m windfall. My retirement goal is met, and I should adopt a more conservative AA.

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Re: Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Thu Dec 01, 2011 6:50 pm

umfundi wrote:Rick,

From your Rules:
Was the money inherited, won, or from another source where you had no previous ownership? Here is where DCA works well. I recommend investing 40 percent now and DCA the other 60 percent over the next 3 years. For example, imagine you won $1,000,000 after tax in a lottery. Invest $400,000 this year and $200,000 per year for the next 3 years. This spreads out your entry-point risk.
Why does DCA "work well" here? How did you arrive at the 40/60 percent rule? What is "entry-point risk"?
It works well physiologically. Investing is 90% in your brain. I arrived at the 40/60 rule because it is palitable. You can change the rule to whatever suits you best.

Your question, what is the "entry point risk"? What does this mean? I have no idea.
I think it's actually simpler than you say. Assume an investor with an established Asset Allocation (AA) and diversified investments now has a lump sum to invest.

1. Is the lump sum actually not "new" money, in that it was part of the existing AA? For example, some bonds mature. Then, simply invest it, all at once, back into the AA.
I agree. A maturing bond is not a new lump sum of money. Individual bonds that mature or stocks that are sold that are already in a portfolio and already part of an asset allocation. They get reinvested immediately. Dividend and interest income is also already part of a portfolio and are reinvested.
2. Is the lump sum "new" money, like an inheritance or lottery windfall? Then,
a. Is the amount large enough that it causes the investor to change their desired AA*? Decide what the AA going forward should be.
b. Invest the lump sum, all at once, into the desired AA, rebalancing other investment assets as required.
This is exactly what I wrote in the article. Sorry it wasn't clear.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Thu Dec 01, 2011 7:20 pm

From a purely technical standpoint, DCA not optimal. Assuming you know what your best portfolio is today, Investing immediately has the highest expected return, as stocks/bonds are always priced to have an expected return. Slowing things down with DCA carries a cost until you are done.

From a behavioral standpoint, DCA may be the practical thing to do if the thought of jumping right in is just too much to handle. But that mindset has more in common with the myriad of other behavioral "mistakes" and mental accounting tricks people play on themselves.

IMHO, getting fully invested according to a well thought out plan as soon as possible is the correct answer. Not easy to do, as we humans tend to anchor to the past and let sunk costs dictate our current decisions.

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Re: Rick's Rules for Lump Sum Investing

Post by bungalow10 » Thu Dec 01, 2011 7:36 pm

I still don't understand why the source of the money matters. $200,000 is $200,000, regardless of where it came from or how you got it. It has the same present value and the same potential whether it was in stocks or Beanie Babies prior to getting the cash.
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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Thu Dec 01, 2011 7:41 pm

Investing is 90% in your brain.
And, to misquote Yogi Berra, "The other half is mental."

The source of the money does matter, psychologically.

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Thu Dec 01, 2011 8:39 pm

Derek Tinnin wrote:From a purely technical standpoint, DCA not optimal. Assuming you know what your best portfolio is today, Investing immediately has the highest expected return, as stocks/bonds are always priced to have an expected return. Slowing things down with DCA carries a cost until you are done.
I don't disagree. But we also know that the market is not perfect and the unexpected happens. This why the "highest expected return" from stocks doesn't alway get realized. Sometimes, investors have to wait a long, long time.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Thu Dec 01, 2011 9:24 pm

bob90245 wrote:
Derek Tinnin wrote:From a purely technical standpoint, DCA not optimal. Assuming you know what your best portfolio is today, Investing immediately has the highest expected return, as stocks/bonds are always priced to have an expected return. Slowing things down with DCA carries a cost until you are done.
I don't disagree. But we also know that the market is not perfect and the unexpected happens. This why the "highest expected return" from stocks doesn't alway get realized. Sometimes, investors have to wait a long, long time.
Yes indeed, but stocks are in fact priced today to have an expected return. What tomorrow brings is unknown and unknowable. DCA is a form of market timing no matter how we look at it. Is market timing with new money somehow better than market timing with old money?

Just my 2 cents.

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DT

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Thu Dec 01, 2011 10:59 pm

Derek Tinnin wrote:
bob90245 wrote:
Derek Tinnin wrote:From a purely technical standpoint, DCA not optimal. Assuming you know what your best portfolio is today, Investing immediately has the highest expected return, as stocks/bonds are always priced to have an expected return. Slowing things down with DCA carries a cost until you are done.
I don't disagree. But we also know that the market is not perfect and the unexpected happens. This why the "highest expected return" from stocks doesn't alway get realized. Sometimes, investors have to wait a long, long time.
Yes indeed, but stocks are in fact priced today to have an expected return. What tomorrow brings is unknown and unknowable. DCA is a form of market timing no matter how we look at it.
If I don't know how stocks are going to perform, it's unknown and unknowable, then I don't see how choosing either lump sum or DCA is a form of market timing. By contrast, market timing, by definition, is acting on how you expect the market to perform.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Thu Dec 01, 2011 11:13 pm

bob90245 wrote:
Derek Tinnin wrote:
bob90245 wrote:
Derek Tinnin wrote:From a purely technical standpoint, DCA not optimal. Assuming you know what your best portfolio is today, Investing immediately has the highest expected return, as stocks/bonds are always priced to have an expected return. Slowing things down with DCA carries a cost until you are done.
I don't disagree. But we also know that the market is not perfect and the unexpected happens. This why the "highest expected return" from stocks doesn't alway get realized. Sometimes, investors have to wait a long, long time.
Yes indeed, but stocks are in fact priced today to have an expected return. What tomorrow brings is unknown and unknowable. DCA is a form of market timing no matter how we look at it.
If I don't know how stocks are going to perform, it's unknown and unknowable, then I don't see how choosing either lump sum or DCA is a form of market timing. By contrast, market timing, by definition, is acting on how you expect the market to perform.
Well, if you don't know what is going to happen tomorrow, the default choice is to invest today since today's investment has a higher expected return...If you defer to tomorrow, that implies you think you might get a better deal, and therefore an attempt to time things to your advantage. right?

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Re: Rick's Rules for Lump Sum Investing

Post by joe8d » Thu Dec 01, 2011 11:16 pm

Rick, good sensible advice.
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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Thu Dec 01, 2011 11:37 pm

bob90245 wrote:
Derek Tinnin wrote:
bob90245 wrote:If I don't know how stocks are going to perform, it's unknown and unknowable, then I don't see how choosing either lump sum or DCA is a form of market timing. By contrast, market timing, by definition, is acting on how you expect the market to perform.
Bob,

Let's suppose you have $100,000 invested in your asset allocation. Fine.

Tomorrow, your Aunt Millie dies, and leaves you another $100,000 in cash. You are far away from your goal of $3m, so Aunt Millie's bequest doubles your investment amount, but does not change your asset allocation. What should you do?

The optimal answer is to immediately invest Aunt Millie's bequest according to your asset allocation.

"No!", you say, "The market may drop." "I am going to spread my investment (from Aunt Millie's cash) over time."

Yes, this is market timing. What if the market does not drop, and goes up? If dollar cost averaging of Aunt Millie's money is the right thing to do, should you not now sell your existing investment and DCA it also?

Lump sum investing, which is investing funds according to your asset allocation as they are available, is not market timing. It is Bogleheading.

(How come that word, "Bogleheading", is not in my spell checker?)

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Re: Rick's Rules for Lump Sum Investing

Post by grabiner » Thu Dec 01, 2011 11:55 pm

bungalow10 wrote:I still don't understand why the source of the money matters. $200,000 is $200,000, regardless of where it came from or how you got it. It has the same present value and the same potential whether it was in stocks or Beanie Babies prior to getting the cash.
There is no mathematical basis for dollar-cost averaging; if the mathematically right way for you to invest your $200,000 is $20,000 a month for 10 months, then the right way for me to invest my $200,000 which is currently in the market is to pull 90% of it out of the market and put it back in over 10 months.

But there is an important psychological basis; it's much easier to say that you won't panic in a bear market than to actually stay the course. This is why dollar-cost averaging is recommended for new investors with a lump sum.

But this assumes that the money is new. If you have $200,000 in a 401(k) and roll it into an IRA when you leave the company, you already had the money invested and know how you will react to market moves, so you should probably put it immediately into the same allocation. If you inherited $200,000 and have never had more than $20,000 in the market, you may want to dollar-cost average it in.
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Re: Rick's Rules for Lump Sum Investing

Post by bertilak » Fri Dec 02, 2011 7:53 am

Didn't Yogi Berra also say something about "Deja vu all over again"?
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Re: Rick's Rules for Lump Sum Investing

Post by rocket » Fri Dec 02, 2011 9:29 am

DCA has meaning from the idea of buying securities monthly.
I think a lot of the readers do not understand what DCA is.

DCA is goofy when considering a Lump sum. DCA is almost the opposite of lump sum.
Is it a lump sum, or not a lump sum? Where is the lump sum, if it is not invested in something.
It usually would be invested in something, maybe a bank saving account or mutual fund.
This thread's concern about DCA is "Market Timing". Everybody that is good at market timing, please give us your name.

I think this lump sum investing and DCA discussion is concerned with investing in EQUITIES, as opposed to a risk free investment.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Fri Dec 02, 2011 9:51 am

Rick Ferri wrote:
umfundi wrote:What is "entry-point risk"?
Your question, what is the "entry point risk"? What does this mean? I have no idea.
Rick and umfundi:

You should ask the guy who wrote this what it means:
This spreads out the entry-point risk into the markets.
He should be easy to locate, he posts here pretty often :wink:

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Fri Dec 02, 2011 10:05 am

Derek Tinnin wrote:Well, if you don't know what is going to happen tomorrow, the default choice is to invest today since today's investment has a higher expected return...
The statement above is internally inconsistent. We don't know that today's investment has a higher expected return.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Fri Dec 02, 2011 10:11 am

I think that someone facing a lump sum investing decision should discuss it with their spouse. They should DCA if the spouse is the Nervous Nellie type bothered by investing a lump sum all at once. But if both parties are the objective sorts that see DCA as stupid then they should lump sum it.

Rick's article proports to give everyone the same advice. Is that the right thing to do for this matter?

Is he telling the objective sorts to DCA even if they think it's stupid because he had some insight into their psychology that tells him they have a sufficiently high risk of regretting it?

I can see why pension fund managers and other investment managers don't lump sum. They might lose their jobs. They make sub-optimal decisions for the same reason that football coaches would rather lose an extra game per season on average than get blamed for optimal decisions to go for it on 4th down.
Last edited by tadamsmar on Fri Dec 02, 2011 1:13 pm, edited 1 time in total.

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Fri Dec 02, 2011 10:19 am

umfundi wrote:
bob90245 wrote:
Derek Tinnin wrote:
bob90245 wrote:If I don't know how stocks are going to perform, it's unknown and unknowable, then I don't see how choosing either lump sum or DCA is a form of market timing. By contrast, market timing, by definition, is acting on how you expect the market to perform.
Bob,

Let's suppose you have $100,000 invested in your asset allocation. Fine.

Tomorrow, your Aunt Millie dies, and leaves you another $100,000 in cash. You are far away from your goal of $3m, so Aunt Millie's bequest doubles your investment amount, but does not change your asset allocation. What should you do?
The relevent data is $100,000 you previously held and the new cash of $100,000 you just received. I don't stop and think about the far away goal.

There is no "should" in this. Investor psychology dominates this kind of decision. I agree with Rick that if the amount of cash you received was relatively small, like $20,000 or less -- using the example given here, then psychological considerations shouldn't dominate the decision.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Fri Dec 02, 2011 10:27 am

Here's an 11 page thread on this issue:

http://www.bogleheads.org/forum/viewtop ... &start=201

All the basic questions are answered there with references to decades old papers.

This has been known to be a behavioral finance matter for decades.

It's irrational but normal to want to DCA rather than lump sum.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Fri Dec 02, 2011 10:34 am

Here's the best paper (best that can be linked to on the web, at least) on the matter:

http://www.jamesegrantcpapc.com/docs/ab ... fordca.pdf

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Fri Dec 02, 2011 10:51 am

bob90245 wrote:
Derek Tinnin wrote:Well, if you don't know what is going to happen tomorrow, the default choice is to invest today since today's investment has a higher expected return...
The statement above is internally inconsistent. We don't know that today's investment has a higher expected return.
Bob, let's not overcomplicate this. The present value of a dollar invested today is greater than the present value of a dollar invested tomorrow. Therefore, DCA is has an expected return inferior to that of lump sum.

Advice to choose DCA when viewed through an academic or investment outcome lens is simply bad advice. It's a triumph of the stomach over the head. Advice to choose DCA to improve the "investment experience" may have merit if it means the alternative is complete paralyisis. If that's the case, time spent on education seems more appropriate than time spent on implementing some arbitrary DCA schedule that does little to make you a better investor.

I realize the need to balance behavioral finance with academic logic, and there is no one-size-fits-all rule on this topic, but the default choice is lump sum IMO because it does in fact have the highest expected return and the lowest expected cost. It may not be what people want to hear, but that's what they should expect to hear. If they still can't stomach the idea of jumping right in no matter what logic and evidence says, then maybe it's a sign that their willingness to accept risk and adhere to a structured approach needs to be reassessed. If DCA is "OK," then what's the point of structure at all?

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Re: Rick's Rules for Lump Sum Investing

Post by WolfpackFan » Fri Dec 02, 2011 10:52 am

The correct answer is to wait until the market declines as far as it ever is going to decline, and then invest the total lump sum of the money at that point.

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Re: Rick's Rules for Lump Sum Investing

Post by bertilak » Fri Dec 02, 2011 11:02 am

WolfpackFan wrote:The correct answer is to wait until the market declines as far as it ever is going to decline, and then invest the total lump sum of the money at that point.
I have found it is just as easy to go back in time (say, to February 2009) and buy then.
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Re: Rick's Rules for Lump Sum Investing

Post by ddb » Fri Dec 02, 2011 11:44 am

Rick Ferri wrote:What do you do with a lump sum?

Lump sums can come from several different sources — a pension payout, inheritance, the sale of property or a business, or perhaps winning the lottery. Here are a few simple rules, or guidelines if you prefer, to help decide on a dollar-cost average or all-in strategy:

4 Rules for Investing a Lump Sum

Rick Ferri
Rick, I vehemently disagree that there are any situations where DCA is appropriate. Consider two investors who are identical in all respects except that:

1. Investor A has a $1 million investment portfolio.
2. Investor B has a $100,000 investment portfolio, and today receives an inheritance of $900,000.

According to your article, Investor B should DCA, while Investor A should presumably stay invested. This is completely inconsistent. If you think Investor B should DCA, then you must also think that Investor A should cash out $900K and beging DCA'ing that back into the portfolio (ignoring tax consequences). Your term "entry-point risk" is just a re-configured way of saying that any invested assets carry risk. A properly-constructed IPS or target allocation has already considered potential volatility.

In my opinion, it is also not sufficient to say that one should DCA because it may help curb future bad investment behavior (buying high, selling low). Again, this is something that should already be addressed by the IPS or target allocation.

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Re: Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Fri Dec 02, 2011 12:08 pm

Rick, I vehemently disagree that there are any situations where DCA is appropriate.
Well, you're wrong. I've met several investors who have left a lump sum sitting in cash for years because they were afraid to do anything with it. DCA is a way to get this money invested and it is definitely appropriate if an investor would not do it any other way.

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Re: Rick's Rules for Lump Sum Investing

Post by ddb » Fri Dec 02, 2011 12:17 pm

Rick Ferri wrote:
Rick, I vehemently disagree that there are any situations where DCA is appropriate.
Well, you're wrong. I've met several investors who have left a lump sum sitting in cash for years because they were afraid to do anything with it. DCA is a way to get this money invested and it is definitely appropriate if an investor would not do it any other way.
If they won't invest as a lump sum, then they don't have a suitable IPS. And also, the fact that some investors have emotions which cause them to do dumb things with their portfolio in no way illustrates that I'm wrong. That's like saying variable annuities with living benefits are a good idea because some people wouldn't invest without them. Isn't it more likely that the investor just requires more guidance or education?

Let's say an investor has a lump sum available, with an IPS of 50% stock/50% bond, and they decide to DCA in 3 equal annual deposits starting today. What they are basically saying is this: In year 1, I want an allocation of 16.67/16.67/66.67 stock/bonds/cash. In year 2, I want an allocation of 33.33/33.33/33.33 stock/bonds/cash. In year 3, I want an allocation of 50/50/0 stock/bonds cash. How is it rational in any world to have a target allocation that shifts so dramtically over such a short time period?

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Fri Dec 02, 2011 1:27 pm

ddb wrote:
Rick Ferri wrote:
Rick, I vehemently disagree that there are any situations where DCA is appropriate.
Well, you're wrong. I've met several investors who have left a lump sum sitting in cash for years because they were afraid to do anything with it. DCA is a way to get this money invested and it is definitely appropriate if an investor would not do it any other way.
If they won't invest as a lump sum, then they don't have a suitable IPS. And also, the fact that some investors have emotions which cause them to do dumb things with their portfolio in no way illustrates that I'm wrong. That's like saying variable annuities with living benefits are a good idea because some people wouldn't invest without them. Isn't it more likely that the investor just requires more guidance or education?

Let's say an investor has a lump sum available, with an IPS of 50% stock/50% bond, and they decide to DCA in 3 equal annual deposits starting today. What they are basically saying is this: In year 1, I want an allocation of 16.67/16.67/66.67 stock/bonds/cash. In year 2, I want an allocation of 33.33/33.33/33.33 stock/bonds/cash. In year 3, I want an allocation of 50/50/0 stock/bonds cash. How is it rational in any world to have a target allocation that shifts so dramtically over such a short time period?

- DDB
You seem to be arguing in favor of two distinct propositions as if they were the same.

1. DCA is wrong in terms of standard finance.

It's clear that Rick agrees with you on that.

2. Isn't it more likely that the investor just requires more guidance or education?

"the investor" is a fiction. Individual investors are real.

Decades of evidence indicate that some investors cannot be educated to be comfortable with investing a lump sum all at once. And it's quite common for investment managers to use DCA for a client to avoid being blamed for the decision to invest a lump sum; this can be a good policy for the manager even if he knows that DCA is not the best policy according to standard finance. Even a guy like you might want to consider what their spouse thinks before investing a lump sum all at once.

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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Fri Dec 02, 2011 1:55 pm

If they won't invest as a lump sum, then they don't have a suitable IPS.
IPS = Investment Policy Statement, or desired asset allocation.

There's the real problem. Even if Dollar-Cost Averaging (DCA) were a reasonable strategy (it is not), it runs counter to the Bogleheads' belief system.

And, a definition or two:

Dollar-Cost Averaging is trickling a (cash) lump sum into investments over time. Rather than invest the lump sum all at once, you make some number of equal dollar investments over some period of time.

Systematic Investing, for example, by payroll deductions into a 401(k) is an exceedingly good thing, and it is NOT dollar-cost averaging as defined above. With Systematic Investing, you are investing the money as soon as it is available.

Keith

PS: Please don't shout at me. These are not my definitions.
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Re: Rick's Rules for Lump Sum Investing

Post by ddb » Fri Dec 02, 2011 2:03 pm

tadamsmar wrote:
ddb wrote:If they won't invest as a lump sum, then they don't have a suitable IPS. And also, the fact that some investors have emotions which cause them to do dumb things with their portfolio in no way illustrates that I'm wrong. That's like saying variable annuities with living benefits are a good idea because some people wouldn't invest without them. Isn't it more likely that the investor just requires more guidance or education?
You seem to be arguing in favor of two distinct propositions as if they were the same.

1. DCA is wrong in terms of standard finance.

It's clear that Rick agrees with you on that.
This is not clear to me. I don't think Rick is a guy who would make a recommendation to a client that he doesn't believe is in their best interest. So, if he recommends DCA to a client, then he must think it's a viable strategy.
2. Isn't it more likely that the investor just requires more guidance or education?

"the investor" is a fiction. Individual investors are real.

Decades of evidence indicate that some investors cannot be educated to be comfortable with investing a lump sum all at once. And it's quite common for investment managers to use DCA for a client to avoid being blamed for the decision to invest a lump sum; this can be a good policy for the manager even if he knows that DCA is not the best policy according to standard finance. Even a guy like you might want to consider what their spouse thinks before investing a lump sum all at once.
Yes, investment managers often recommend DCA. This is more of a CYA strategy for the firm than guidance based on a fiduciary duty, in my opinion.

If an investor doesn't have an IPS within his/her comfort level, then s/he shouldn't invest at all until s/he figures out the IPS.
If an investor does have an IPS within his/her comfort level, then s/he should lump sum, else the IPS is not suitable.

Either way, no room for DCA.

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB

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Re: Rick's Rules for Lump Sum Investing

Post by dyangu » Fri Dec 02, 2011 3:08 pm

ddb wrote: If an investor doesn't have an IPS within his/her comfort level, then s/he shouldn't invest at all until s/he figures out the IPS.
If an investor does have an IPS within his/her comfort level, then s/he should lump sum, else the IPS is not suitable.

Either way, no room for DCA.
- DDB
Investing is not just a math game and advisers should not make recommendations purely on math. If you asked people to gamble and let's say heads, they win $1, tails they lose $0.95, they will play. But change this to $10,000 and $9,000, most people will not play. DCA is an excellent psychological tool to make investors feel better.

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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Fri Dec 02, 2011 3:41 pm

So, if he recommends DCA to a client, then he must think it's a viable strategy.
For that client, quite possibly. This is behavioral, not standard economics.

For a moment, let's put aside the basic tenets that you should know your goals and risk tolerance, and have an Investment Policy Statement or Asset Allocation that you adhere to.

Suppose you have some amount of cash. You can invest it all at once (Lump Sum), or you can divide it in 12 and invest equal dollar amounts each month for a year (Dollar Cost Average).

If you DCA, at the end of the year you will have less money than the LS about two-thirds of the time. One-third of the time, you will have more. In either case, not by much.

If you DCA, you will have lower risk. But, you also have a likely lower return. That risk / return tradeoff is not optimal. You would be better off to invest in a less risky portfolio all at once, if you want less risk.

In my opinion, DCA is not infeasible, and it is not a sinful or mistaken thing to do. Yes, it's not the best choice, but there are far bigger mistakes you can make.

The issue I have is that the anti-DCA chorus can spill over into discouraging people from systematic investing. I went through the finance section at my local library. Almost every book that mentioned "dollar-cost averaging" used it in the context of systematic investing.

Keith
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Mr. Bogle on "Dollar Cost Averaging"

Post by Taylor Larimore » Fri Dec 02, 2011 3:43 pm

In Bogle on Mutual Funds Mr. Bogle wrote:
When you receive a lump sum of dollars to invest, the most important rule is to move to your desired investment allocation position gradually. Don't hurry to invest all your assets at once, and don't let anyone persuade you to act precipitately.

In the case of a $100,000 cash payment, you might invest 70% of your assets in reserves or short-term bond funds and 30% in stock funds and longer-term bond funds. This initial allocation might be followed by 10% shifts from reserves to these stock and bond funds at the close of each subsequent quarter until your desired allocation is reached.

This program has the obvious dollar-cost-averaging benefit of reducing risk by investing over time, and the more subtle benefit of avoiding the bandwagon effect that seems to compel investors to plunge into stocks all at once after prices have risen sharply or to eschew them completely after prices have taken a plunge.
Best wishes
Taylor
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Re: Mr. Bogle on "Dollar Cost Averaging"

Post by umfundi » Fri Dec 02, 2011 4:55 pm

Taylor Larimore wrote:In Bogle on Mutual Funds Mr. Bogle wrote:
When you receive a lump sum of dollars to invest, the most important rule is to move to your desired investment allocation position gradually. Don't hurry to invest all your assets at once, and don't let anyone persuade you to act precipitately.

In the case of a $100,000 cash payment, you might invest 70% of your assets in reserves or short-term bond funds and 30% in stock funds and longer-term bond funds. This initial allocation might be followed by 10% shifts from reserves to these stock and bond funds at the close of each subsequent quarter until your desired allocation is reached.

This program has the obvious dollar-cost-averaging benefit of reducing risk by investing over time, and the more subtle benefit of avoiding the bandwagon effect that seems to compel investors to plunge into stocks all at once after prices have risen sharply or to eschew them completely after prices have taken a plunge.
Best wishes
Taylor
Taylor,

That's not the best advice but, from a behavioral point of view, it might be good advice. "Don't rush, make a plan, and stick to it."

I wonder what Mr. Bogle would say today? (the book was published in 1993, so the advice is about 20 years old.)

After all, someone I greatly respect said yesterday, referencing advice with which they now disagree:
The writer sounds like me 40 years ago.


Keith :wink:
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Re: Rick's Rules for Lump Sum Investing

Post by bertilak » Fri Dec 02, 2011 5:07 pm

Personally, I would hate to have an adviser tell me what to do based on what he thought would make me feel comfortable. I would expect an adviser to tell me what's best. I can get feel-good advice for free from lots of places.

If I need education, then give me that, not a sugar pill.
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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Fri Dec 02, 2011 5:22 pm

Derek Tinnin wrote:
bob90245 wrote:
Derek Tinnin wrote:Well, if you don't know what is going to happen tomorrow, the default choice is to invest today since today's investment has a higher expected return...
The statement above is internally inconsistent. We don't know that today's investment has a higher expected return.
Bob, let's not overcomplicate this. The present value of a dollar invested today is greater than the present value of a dollar invested tomorrow. Therefore, DCA is has an expected return inferior to that of lump sum.
I am not overcomplicating this. What I am doing is challenging your assumptions. This is something you do not wish to do. That is fine. I will let this conversation end here.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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More than one road to Dublin.

Post by Taylor Larimore » Fri Dec 02, 2011 5:25 pm

Hi Keith:

Your post gave me a chuckle.

Statistically, dumping a large sum of money into a stock/bond portfolio will probably result in a larger return than the same amount of periodic contributions over the same period of time.

However, many investors will leave the stock market forever if their equities plunge 40 or 50% immediately after a lump-sum investment (Mr. Bogle's point).

The important thing is to get started.

There is more than one road to Dublin.

Best wishes.
Taylor
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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Fri Dec 02, 2011 5:40 pm

bob90245 wrote:
Derek Tinnin wrote:
bob90245 wrote:
Derek Tinnin wrote:Well, if you don't know what is going to happen tomorrow, the default choice is to invest today since today's investment has a higher expected return...
The statement above is internally inconsistent. We don't know that today's investment has a higher expected return.
Bob, let's not overcomplicate this. The present value of a dollar invested today is greater than the present value of a dollar invested tomorrow. Therefore, DCA is has an expected return inferior to that of lump sum.
I am not overcomplicating this. What I am doing is challenging your assumptions. This is something you do not wish to do. That is fine. I will let this conversation end here.
Bob, what is not clear about present value? Is this not crystal clear? If you buy a CD paying 5% today vs. buying a 5% CD next year, which is worth more in 5 years? simple math right?

What assumptions are you challenging?

When you say we don't know that today's investment has a higher expected return, don't ingnore the word "expected." Big differences can occur between expected vs. actual, but we make decisions based on expected.

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Re: Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Fri Dec 02, 2011 5:41 pm

bertilak wrote:Personally, I would hate to have an adviser tell me what to do based on what he thought would make me feel comfortable. I would expect an adviser to tell me what's best. I can get feel-good advice for free from lots of places.

If I need education, then give me that, not a sugar pill.
Many people cannot handle the truth. Ask Alan Roth or anyone who talks with hundreds of people per year. What is "technically" the best solution is not always the best solution because emotion and personality have a 50 percent say in how money is invested. I call it the Ying and Yang of investing. If it was as easy as 1,2,3 then advisors would have disappeared years ago.

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The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.

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Eric Hass "Reading Room"

Post by Taylor Larimore » Fri Dec 02, 2011 5:49 pm

Hi Bogleheads:

Eric Haas has a collection of articles and studies about the pros and cons of Dollar-Cost-Averaging:

http://www.altruistfa.com/readingroomar ... tAveraging

Best wishes.
Taylor
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Re: Rick's Rules for Lump Sum Investing

Post by FabLab » Fri Dec 02, 2011 6:13 pm

Rick Ferri wrote:

Many people cannot handle the truth.

Rick Ferri
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Re: Rick's Rules for Lump Sum Investing

Post by brick-house » Fri Dec 02, 2011 8:02 pm

ddb wrote:
Let's say an investor has a lump sum available, with an IPS of 50% stock/50% bond, and they decide to DCA in 3 equal annual deposits starting today. What they are basically saying is this: In year 1, I want an allocation of 16.67/16.67/66.67 stock/bonds/cash. In year 2, I want an allocation of 33.33/33.33/33.33 stock/bonds/cash. In year 3, I want an allocation of 50/50/0 stock/bonds cash. How is it rational in any world to have a target allocation that shifts so dramtically over such a short time period?
If I put a windfall lump sum into the 50 stock/50 bond portfolio in 2007 - then by March 2009, my 50/50 portfolio was 25 stock/75 bond due to the 50-60% downturn in the stock market. A million dollar lump sum into 50/50 would be down $250,000. How is that rational?

Expected stock returns are jive in the short and mid term. Instead, short and mid term stock market returns carry crazy volatility. IMHO, it seems perfectly rational to sacrifice "expected return" for a plan that will be followed to completion. Shoot, if the market pukes after my first DCA deposit - I might even decide to speed up the DCA process since my expected return has just improved dramatically.
You don't need no gypsy to tell you why- Greg Allman

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Fri Dec 02, 2011 8:32 pm

Derek Tinnin wrote:... but we make decisions based on expected.
I don't agree. Investors make decisions based on psychology. It is the dominant consideration once it is established that there is the need and the ability to invest. On the other hand, if investors made decisions base only on expected, then everyone's portfolio would contain no bonds -- it has lower expected returns.

Taking this line of reasoning to it's logical conclusion, then investors should load up on only those asset classes with the highest expected return: small-cap value, emerging market stocks and the like. Maybe even leverage up.

Unfortunately, we know this doesn't work. We are lucky to have Long Term Capital Management and Lehman Brothers to use as cautionary examples.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Fri Dec 02, 2011 10:25 pm

bob90245 wrote:
Derek Tinnin wrote:... but we make decisions based on expected.
I don't agree. Investors make decisions based on psychology. It is the dominant consideration once it is established that there is the need and the ability to invest. On the other hand, if investors made decisions base only on expected, then everyone's portfolio would contain no bonds -- it has lower expected returns.

Taking this line of reasoning to it's logical conclusion, then investors should load up on only those asset classes with the highest expected return: small-cap value, emerging market stocks and the like. Maybe even leverage up.

Unfortunately, we know this doesn't work. We are lucky to have Long Term Capital Management and Lehman Brothers to use as cautionary examples.
Are we having a conversation about the same topic?

Stocks and bonds alike both have expected return. The level of expected return isn't the point. The point is that a dollar invested today is expected to grow to a larger amount than a dollar invested next year, regardless of whether it is put in a stock or a bond or cash...basic time value of money. Somebody help me out here lol.

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Re: Rick's Rules for Lump Sum Investing

Post by JimInIllinois » Sat Dec 03, 2011 2:05 am

People don't really want to maximize expected return or risk-adjusted return. They want to minimize regret. The biggest potential cause of regret is the market dropping shortly after investing the entire lump sum, because you could have avoided it by waiting a few weeks. Waiting is good because impatience is bad, so you lost your money because you were impatient and didn't wait for the market drop, which was obvious in hindsight. You won't regret the lump sum if the market drops a year later, because waiting a year to invest would have been unreasonable, so you only really care about a loss that quickly follows an investment. DCA is the logical compromise, and at worst you'll only regret the timing of your last investment before a market drop, which is only 1/12 the size of the lump sum if you DCA over a year.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Sat Dec 03, 2011 6:22 am

bertilak wrote:Personally, I would hate to have an adviser tell me what to do based on what he thought would make me feel comfortable. I would expect an adviser to tell me what's best. I can get feel-good advice for free from lots of places.

If I need education, then give me that, not a sugar pill.
Different advisors/writers handle this differently.

Swerdroe tells what is best, while granting that it's better to use DCA than to be too scared to invest at all. Malkiel, Bogle, Ferri offer the sugar pill.

One drawback to the sugar pill approach is that it leaves the impression that the guru is ignorant of the findings of standard finance. Constantinides debunked DCA in 1979, and since then its been part of behavorial investing, investment gurus should know that. Malkiel does make a brief mention that some think DCA is a money loser.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Sat Dec 03, 2011 6:30 am

JimInIllinois wrote:People don't really want to maximize expected return or risk-adjusted return. They want to minimize regret. The biggest potential cause of regret is the market dropping shortly after investing the entire lump sum, because you could have avoided it by waiting a few weeks. Waiting is good because impatience is bad, so you lost your money because you were impatient and didn't wait for the market drop, which was obvious in hindsight. You won't regret the lump sum if the market drops a year later, because waiting a year to invest would have been unreasonable, so you only really care about a loss that quickly follows an investment. DCA is the logical compromise, and at worst you'll only regret the timing of your last investment before a market drop, which is only 1/12 the size of the lump sum if you DCA over a year.
Some think that way, but others know that the decision to leave their current nest egg in the market each day is a decision that is just as fateful and reasonable (or unreasonable) as the decision to invest a lump sum on a given day.

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