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.
This is the most dangerous advice I've seen you submit, and I respect you're views. Investors should never intentionally make decisions based on emotion--at that point we are speculating and not investing.
1. The idea is to develop a portfolio with expected returns that are enough to reach one goals with the least risk
. Properly done, that includes some combo of stocks/bonds, US/foreign, and large/small & growth/value, etc..
2. Now, either (a) your newfound capital was expected and you have already accounted for it in devising your asset allocation, or (b) it was "found money" which allows you to lower risk to reach the same goals or increase your goals for the same level of risk.
3. If one decides to sit in cash and parcel out their money over a period of weeks, months, or quarters, they are betting on the fact that over this period of time, cash offers a better opportunity to reach one's goals. In essence, you are guessing you can predict when the markets have underpriced risk relative to expected returns. This, pure and simple, is speculation. To take this to the logical extreme, if we ignore taxes and transaction fees, one should periodically adjust their portfolio between their IPS AA and cash based on when markets failure to properly price risk/return. Obviously this makes no sense.
Of course, if one simply cannot bring themselves to "plunge in", then "wadding in" over the shortest period possible is the next best option. However, 2 caveats apply:
i. you will probably opt to DCA when perception of risk/expected returns is highest, costing you the most
ii. If you are uncomfortable investing new $ at your chosen AA, questions around existing $s are probably next, so it might make sense to revisit your AA
Finally, on the topic of which option (DCA vs Lump Sum) makes the most sense on paper from a ris/return standpoint on mult-asset class portfolios, everyone should google: "To Wade or Plunge" by Truman Clark
. The best piece (by far) I have seen on the topic.