It’s the week your big bonus from work hits your bank account. Or you receive a sizeable cash gift or inheritance from a relative. Perhaps you have proceeds from the sale of your home or cash from a rollover retirement account. Or you’ve saved money for a few years because of rumors about the stock market.
Whatever the reason, you now have a large sum of cash. And you want it to start making more money. To capitalize on the power of compound interest, you’re ready to invest it.
But after doing some research and talking it over with financially savvy family and friends, you still aren’t sure whether you should invest it all at once or spread it out over time.
There’s a reason for the mixed messages you’re getting. There isn’t one right answer.
While research from Vanguard – one of the world’s largest investment management companies – indicates lump sum investing is the method more likely to grow your wealth over time, your emotions matter too.
Once you account for your possible reactions to significant market changes, it gets more complicated than following past trends and statistics.
Whether to invest your money in a lump sum or use a dollar-cost averaging strategy to spread investments over time is a frequent question.
Let’s take a look at the benefits of each approach to help you make a smart decision about how to invest your money.
Lump Sum Investing
Lump sum investing isn’t hard to understand. You put a large amount of money into investment vehicles – such as stocks or bonds – all at one time. You don’t wait and see what happens to the price per share over time or invest in intervals.
The benefit of plunging your money into the market all at once is you taking advantage of the growth in the market sooner. Since the stock market has historically trended up over time, your money has longer to realize market gains.
As stated above, research supports lump sum investing in a majority of situations when someone is questioning how to invest a large amount of money.
Investing equal parts of a large sum of money at planned intervals – regardless of fluctuating price levels – is called dollar-cost averaging. You may be familiar with this strategy if you invest in a retirement account on a regular basis through your employer.
With this method, you invest a set amount each pay period or each month, regardless of what the market is doing. And you won’t normally cancel an investment just because the market is volatile.
Using the dollar-cost averaging approach helps newer investors or those with low-risk tolerance adjust to and manage emotions around the roller coaster of ups and downs the stock market experiences routinely.
How Should You Invest?
After reading more about how to invest your money, it still comes down to what works best for you. It’s personal finance. While you can take advice from others and continue to do research, your tolerance for risk is key.
Lump sum investing tends to work best for people who have higher risk tolerances, stable employment, and adequate liquidity. They can manage their emotions about money while focusing on long-term goals. Downturns in the market won’t spook them into selling investments.
Dollar-cost averaging still may be the best option for some people – even though they miss out on exposing the full sum of money to the stock market sooner. By spreading out investments over time, the risk is also spread out.
If your risk tolerance is low, a market decline after investing a lump sum of money may hurt your long-term investing success. If your emotions lead you to be fearful, sell shares at the wrong time, and change your long-term investing strategy – it can negatively impact wealth building.
Another thing to consider is the size of the lump sum of money and your age. Is the lump sum $5,000 or $50,000? It may make a big difference in your risk tolerance and overall strategy for investing that amount of money.
Final Thoughts on Investing Sums of Money
To build a secure financial house, you want your money to start working for you as early as possible. But it’s also important to take time and learn about different investing strategies like dollar-cost averaging and lump sum investing This way you can determine what is right for you and avoid blindly following the advice of others or something you read online.
Whether to “plunge” or “wade” into the market with a large sum of money is an emotionally charged issue for some people. As an investor, you should always have clear objectives aligned with your financial goals and risk tolerance.
Although it would be easier to invest a lump sum and it would likely be a good long-term decision, you might not be able to sleep at night if the market crashed a few weeks after you made a lump sum investment.
If that were to happen, you might make choices to reduce your stress and anxiety that aren’t good for your finances.
What should you do if you don’t have a large sum of money to invest? Don’t wait to build one up.
The sooner you invest, the faster you’ll be making interest on interest. Keep reminding yourself of the saying – invest early and often. Good money habits help build long-term wealth too!