A rising stock market is good news if you’re invested, but it can be frustrating—and expensive—if you’re waiting for a pullback to put cash to work.
“Bad timing risk” is double-edged. On one hand, we don't want to buy in to the market only to immediately suffer a large drawdown. On the other hand, sitting on the sidelines during a market rally can be just as damaging to our long-term growth potential.
Markets tend to grind higher over time, and climb the “wall of worry,” so the best strategy is usually to put cash to work straight away, especially for everyday deposits like paychecks. For large lump sum deposits, however, the stakes of market timing risk can be higher.
One strategy for managing market timing risk is to implement a phase-in strategy, also known as a “dollar cost averaging” strategy, which works by putting a certain dollar amount to work at regular intervals, regardless of price, until you are fully invested. For example, if you want to put $6 million into a portfolio over 12 months, you would put $500,000 into the market each month.
Having a formal phase-in plan—and committing to follow through with it—can help you to balance the risk of missing out on a rising market and the risk of buying just before a dip.
In order to learn which types of phase-in strategies are the most successful, we looked at three factors:
- The historical opportunity cost of holding cash
- The likelihood of stock market losses
- The historical track record of phase-in strategies versus an "all-at-once" approach
In general, we recommend against trying to invest cash at the best possible moment. After all, when time is on your side, timing doesn't matter much. Therefore, investing your cash immediately is the best strategy for everyday cash inflows.
However, the math can be a little different if you've received an abnormally large deposit, such as from the sale of your business or from an inheritance. When your 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 using a dollar cost averaging strategy.
With this in mind, here are our recommendations for phasing a large cash deposit into the market:
- Put bonds to work in a lump sum—only phase-in the stock allocation of your portfolio.
- Phase into the stock market within 12 months.
- Accelerate your phase-in after a 5% or 10% market selloff.
- Consider strategies, such as structured investments and options like call buying and put writing, which can provide protection against the opportunity cost of phasing into the market
- If you have specific concerns, address them by customizing the phase-in plan with your financial advisor.
If you have cash sitting on the sidelines and you’re worried about missing the start of the next bull market, be sure to speak with your financial advisor about developing a phase-in strategy that you can stick with.
Remember: Time in the market is more important than timing the market.
Main contributor: Justin Waring