How to invest a lump sum of money
Investing a lump sum of money comes down to the question of your tolerance for risk.
POINTS TO KNOW
- Dollar-cost averaging spreads the risk of investing.
- Lump-sum investing gives your investments exposure to the markets sooner.
- Your emotions can play a role in the strategy you select.
The lump-sum approach vs. dollar-cost averaging
Suppose you received a windfall. Someone gave you a gift or you inherited a lot of money. Maybe you hit the lottery jackpot or got a huge bonus.
Here's the question you face: Should you invest it all right away or in smaller increments over time, a strategy known as dollar-cost averaging?
All at once ...
Investing all of your money at the same time is advantageous because:
… Or slow and steady
What the research says
Our research indicates that it's prudent to invest a lump sum immediately.
Markets going up …
If markets are trending upward, it makes sense to implement a strategic asset allocation as soon as you can.
History shows that investors taking such a risk have been rewarded with positive returns over the long run that should be greater than the expected return of cash investments.
… But what if they go down?
You may be thinking: What if I invest this huge sum of money at once and the market takes a downturn soon after? What happens to my returns then?
If that's your mindset, dollar-cost averaging may be the strategy for you. In other words, you don't want to have any regrets and you want to minimize the downside risk.
Weigh your emotionally based concerns carefully against what the research shows:
- The lower expected long-term returns of cash compared with stocks and bonds.
- Delaying investment is itself a form of market-timing, something few investors succeed at.
Money for trading
A way to invest by buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. You purchase more shares when prices are low and fewer shares when prices rise, avoiding the risk of investing a lump-sum amount when prices are at their peak.
The trading of a universe of investments, based on factors like supply and demand. For example, the "stock market" refers to the trading of stocks.
The profit you get from investing money. Over time, this profit is based mainly on the amount of risk associated with the investment. So, for example, less-risky investments like CDs (certificates of deposit) or savings accounts generally earn a low rate of return, and higher-risk investments like stocks generally earn a higher rate of return.
An investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.
A loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.
Very short-term investments—such as money market instruments, CDs (certificates of deposit), and Treasury bills—that mature in less than one year. Also known as cash reserves.
Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.
The degree to which the value of an investment (or an entire market) fluctuates. The greater the volatility, the greater the difference between the investment's (or market's) high and low prices and the faster those fluctuations occur.
A single unit of ownership in a mutual fund or an ETF (exchange-traded fund) or, for stocks, a corporation.
The way your account is divided among different asset classes, including stock, bond, and short-term or "cash" investments. Also known as "asset mix."
An investment strategy based on predicting market trends. The goal is to anticipate trends, buying before the market goes up and selling before the market goes down.