6

I asked a similar question last year, and got great advice. This year, there's a new wrinkle.

I previously had automatic investments set up to move a small amount of money each day from cash to a couple mutual funds. The amount that I would move each month was roughly my monthly income minus my monthly spending, so it was kind of a standard "money in, money out" thing.

A few changes this year:

  • At the end of last year, I moved, and I'm spending much more on rent.
  • As I get older, I'm making more money, and thus am spending a bit more
  • As I get older and make more money, a higher and higher percentage of it is in my year-end bonus. For example, in 2010, my salary was 65% of my total earnings, and it's been decreasing (this year it should be under 55%).

Long story short, I no longer have "excess" money each month (I now spend more than I take in each month), and the lump sum bonus is bigger. This was a conscious decision, and while I don't like being "cash-flow negative" with respect to my salary, I know it's basically necessary unless I never increase my spending. I'm still saving over 40% of my take-home pay.

I liked the "invest it as it comes in" plan I previously had, because there was no market timing involved. But now, if I invest on a regular basis, then I'm implicitly timing the market (because I currently have all the money that I can invest this year, as opposed to the past when I would accumulate it as I'd invest it).

If I continue to invest daily (throughout the year), then I'll have a large amount of cash sitting in a savings account. I feel like I'd be implicitly timing the market (by not investing it all now, I'd be betting that the market drops). (And furthermore, this would be counter to the idea that money should be in the market as opposed to cash because on average the market will give me a higher return).

But if I invest it all now (or, say, over the next couple months), then I won't be investing anything at all from April to December, and thus will be betting that the market is at a low.

I'm not really comfortable with either option - I don't like the idea of a lot of cash just sitting there for months and months, but I also don't want to invest a lot in the first quarter of the year, but nothing for the remainder.

What's the best thing to do? Is there some reasonable compromise? Feel free to ask any relevant questions and I'll edit the question below.

  • Reading the title on the HNQ list I thought this would be asking about dealing with cash-flow negative with the yearly bonus making up the rest without any investing going on. That would have been an interesting question too, I think... – Michael Apr 12 '17 at 18:20
7

Essentially, your question is "lump sum vs DCA" and your tags reflect that.

In the long run, lump sum, say a Jan 2 deposit each year, will beat DCA by about 1/2 the average annual market return. $12,000 will see a 10% return, vs, $1,000/month over the year seeing 6%. What hurts is when the market tanks in the first half of the year and you think DCA would have helped. This is a 'feeling' issue, not a math problem.

But. By the time you have $100K invested, the difference of DCA vs lump sum with new money fades, as new deposits are small compared to the funds invested. By then, you need to know your target allocation and deposit to keep that allocation with new money.

1

You will maximize your expected wealth by investing all the money you intend to invest, as soon as you have it available. Don't let the mythos of dollar cost averaging induce you to allocate more much money to a savings account than is optimal. If you want the positive expected return of the market, don't put your money in a savings account. That's especially true now, when you are certainly earning a negative real interest rate on your savings account.

Dollar cost averaging and putting all your money in at the beginning would have the same expected return except that if you put all your money in earlier, it spends more time in the market, so your expected return is higher. Your volatility is also higher (because your savings account would have very low volatility) but your preference for investment tells me that you view the expected return and volatility tradeoff of the stock market as acceptable.

If you need something to help you feel less stress about investing right away, think of it as dollar cost averaging on a yearly basis instead of monthly. Further, you take take comfort in knowing that you have allocated your wealth as you can instead of letting it fizzle away in real terms in a bank account.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.