Three ways to invest your lump sum

This can feel uncomfortable for many investors, given the risk of investing close to a market peak. But financial theory would suggest that putting a deposit to work straight away is often the best option, since risk assets typically trend higher. The S&P 500 trades within 5% of a record high 60% of the time, and only 12% of the time more than 20% below its last all-time high.
These factors tell us that, on average, putting funds to work all at once will have a modest edge over strategies that phase in capital or wait for a sizable correction. The likelihood of forgoing capital appreciation—and the size of the performance drag—is significantly higher for longer phase-in time frames. And the potential market timing benefits are much lower for safer and more-diversified portfolios due to their smoother and more consistently positive return streams. On the other hand, the average cost of waiting is greater for more aggressive strategies, whose expected returns are higher.

Alternatives to an "all at once" approach

Although the "all at once" math is well and good for everyday deposits—where the law of large numbers allows investors to harness a statistical edge—the math is different for large lump sum deposits. When an investor's deposits are fewer and more "lumpy," the cost-benefit is shifted, and the potential risk of bad timing becomes more prominent, and there can be psychological benefits of phasing into markets.

Of course, with large deposits the potential cost of bad market timing is greater. Since World War II it has taken an equity-only portfolio just over two years (26 months) on average to recover from a trough back to a prior market high. This would be a distressing wait for an investor who has mistimed a large windfall investment.

The potential for such an eventuality would be mitigated by investing directly in government bonds – which are less volatile – and phasing into riskier assets – known as "dollar cost averaging." We believe the best strategy is to establish a set schedule, and to accelerate each phase-in tranche if there is a market dip of at least 5%.

As a result, putting bonds to work in a lump sum can help to mitigate the potential opportunity cost of a phase-in strategy. In addition, if there is a chance to buy stocks during a dip, the investor's bond holdings may rally due to a flight-to-quality, resulting in some additional capital to deploy as the investor "rebalances" into the stock allocation.

Implementing a put-writing strategy

A put-writing strategy enables investors to earn a premium by giving others the right to sell them a security or exchange-traded fund (ETF) at an agreed-upon price – typically a discount to the current market price. If the market does not fall, the option expires worthless, and the put-writer keeps the premium. If the market falls, the put-writer – who had been intending to increase exposure to equities anyway – ends up taking delivery of the stock. While this strategy is not without its drawbacks, it can mitigate the drag on returns as an investor gradually enters the market.

Buying call options

The biggest risk of any phase-in strategy is "opportunity cost," where markets rally sharply, resulting in forgone gains when the investor eventually buys at a higher price. Call options are one way to help defray this opportunity cost. 

Using structured investments

As an alternative to directly purchasing option strategies or other derivatives, some investors may be willing to fully commit their cash upfront in exchange for a structured investment that provides some combination of these strategies' characteristics. For example, some structured investments limit upside participation in an underlying index, in exchange for downside protection, a fixed coupon payment until maturity or other features to adjust the likely distribution of returns.