Should You Invest Your Extra Cash All at Once? -Episode 77

Are you hesitant to invest your extra cash? If that emergency fund has turned into an emergency fortune, it’s probably time to let your money spread its wings in the market. In this episode of Dentist Money™, Reese & Ryan discuss findings from a Vanguard study which compares two common approaches to investing large amounts of cash: Lump Sum Investing and Dollar Cost Averaging. They explain the tradeoffs of each approach and the factors to consider before deciding which strategy will work best for you.

Podcast Transcript:

Reese Harper: Welcome to The Dentist Money Show, where we help dentists make smart financial decisions. I am your host, Reese Harper. I am joined by my trusty old co-host, Sir Ryan Isaac.

Ryan Isaac: Good afternoon, thanks for the invitation back to the show, Reese. I appreciate being the trusty old side kick every week.

Reese Harper: The producing team usually has you on the rocks after every show. You are lucky you are back this time. Last one you went rogue and we are going to have to keep you on task this time, sir. No tangents, ok?

Ryan Isaac: I get the script at the end of each week, and I always look to see if my character is being killed off or not. But so far so good, I’m still here.

Reese Harper: You’ll know if someone else’s name shows up in the script.

Ryan Isaac: It’s like, “distant screaming”, what does that mean!? Oh, they are introducing the new co-host.

Reese Harper: Then there will be a documentary about this.

Ryan Isaac: It will be big. The next Making a Murder.

Reese Harper: What are we even talking about today?

Ryan Isaac: Today we are going to talk about one of the scariest decisions that dentists have to make. That could actually be a lot of things, one of them is specific because we have been having this conversation a lot lately.

Reese Harper: What they do care about is… if they are sitting on a large lump sum of money it is very scary for them to invest it. That is a very common theme. Their private checking account will have a large quantity of cash in it and now we tell them it isn’t good to let their money sit in the bank forever.

Ryan Isaac: People know, they know that.

Reese Harper: It is hard to actually do something about it. People have a tendency to just sit. They are like, “I like that idea, it feels good to say that I need to invest the money, but it feels better to not invest it.” Cash does not move. It just feels good.

Ryan Isaac: Unless you look at it forty years later, then it doesn’t feel good.

Reese Harper: I am talking about people who are in their late forties that have let a lot of money piled up. We are talking about dentists who have a large amount of money in their bank account, we are talking about people who have sold a practice and have cash, we are talking about inheritance, we are talking about people who have saved money every month in a savings account. Now they have a large amount there and they have never really invested it, and they have this moment where they realize it is time to do something about this.

Ryan Isaac: It is time.

Reese Harper: One of the behavioral financial characteristics that we talk about is the regret mentality. It is the fear of actions of commission. They feel worse than actions of omission. Meaning if I just sit on my money and don’t do anything, even though that is a bad thing and that is hurting me because I am actually losing money, it is still easier than investing it. Let’s say I have $250,000 sitting there. I could be earning 4% a year on that. That is my opportunity cost.

Ryan Isaac: That is very conservative.

Reese Harper: Ya, very conservative. That is about $10,000 a year. So it is costing me $10,000 a year or roughly $800 a month. I am losing $800 a month by just letting my money sit. Here is the mental error. I feel like if I invest the money and I actually lost some of it or it went down, that would be much more painful. I treat these errors of commission of losing money or potentially losing money worse than I treat the errors of omission of just sitting on my cash and letting it eat away and not earn me anything. I think it is important to identify that that is the behavioral thing that is going on. It is a real issue that has affected me in my life, and continues to. It affects a lot of professionals, especially dentists. You do pile up a fair amount of cash in those early years where you don’t have taxes due, you’re 179 is kicking in, your building is written off, it gets real comfortable. You are like, “I have five years of overhead in this account.” It feels great. You know doctor, you could probably last for like five years right now on your practice checking account. Does that feel good?

Ryan Isaac: Is that rational?

Reese Harper: Anyway, Ryan and I have talked a lot about this because we have tons of calls and this week we had a case where it was somebody in their late forties, in a multi million dollar practice, and this person had piled up North of a million dollars in liquidity. North of a million dollars of cash in practice checking, entity accounts, and savings accounts. This guy has got to have seven bank accounts each with six figures and some are high six figure balances. One was over seven figures. That had just happened over a long period of time. You have this crossroads as an advisor where I’m looking at that going, “man, they have that opportunity cost that they have lost over ten or twelve years of not earning anything.” Imagine if you have a million or more, you have lost thousands of thousands of dollars every month. Especially in the last ten years. We have a conversation with people, and this client knew it was time.

Ryan Isaac: I am not going to touch it.

Reese Harper: It can feel like I have bought my house, my boat, my cars, my cabin, my timeshare…just kidding.

Ryan Isaac: Easy now…

Reese Harper: I was waiting for you to smile, ok? Anyway, so they got all of their main stuff that they need. They have the yacht, just kidding, I’ll stop.

Ryan Isaac: What helped this conversation, which is what we are getting into, was to help answer this question. I am not just going to listen to what you have to say.

Reese Harper: Ya, no one actually trusts me. I am just a podcast host.

Ryan Isaac: We went and found some authority from Vanguard, a research paper. Everyone trusts Vanguard.

Reese Harper: We didn’t find this this week. You are making it sound like we just found it.

Ryan Isaac: We just uncovered it! Fine, it was uncovered in 2012 and we have known about it for six years.

Reese Harper: We took this paper that Vanguard published and we were able to show the client some statistics that really helped him make a decision. The question that this guy was struggling with was what? Ryan?

Ryan Isaac: He said, “I’m sitting on all this stuff, what if tomorrow everything tanks. Therefore, should I just put in little chunks to see how it does? If it does well, I will put in more?” I would argue that you wouldn’t because as it keeps climbing higher and higher it is scarier to put it in.

Reese Harper: The choice is, “do I dump it all in today, or do I layer it in?” Here is the thing, there is a slow process that you can invest money in. That is called dollar cost averaging. Most of you now have heard that term and are familiar with it. Then there is a term called lump sum investing. We might refer to it on the show today as LSI, lump sum investing, or DCA, dollar cost advertising. Now you are in the cool crowd because you know.

Ryan Isaac: We just like giving you acronyms.

Reese Harper: Those two things will be the way we reference this debate. We will try to show you what the pros and cons are of doing it both ways. This client knew that it was time to start rolling in some money out of his checking account and start growing it a little bit. That was the question though, “should I do it in small amounts, or should I do it all at once?” Tell them a little bit about Vanguard’s study on the comparison between whether you should do it slowly or lump sum.

Ryan Isaac: Well, let me back up for a second. Everyone always asks that, “what do you think? What is the market going to do tomorrow?”

Reese Harper: Ya, you should guess Ryan. You guess because that will make me feel better about my predictions.

Ryan Isaac: Make your most accurate market prediction…GO! No, the way to answer that is with some data that helps, and other things we will get into later. If you just Google Vanguard lump sum investing versus dollar cost averaging, the study will show up, it was done in 2012. It’s not too hard to digest. Anyway, they wanted to test what would happen at any given point in the last ninety years in the market if you put in a million bucks all at once and held it for ten years or if you slowly bled in that million dollars through DCA over any period of time ranging from six months to thirty-six months.

Reese Harper: Just to clarify, for those of you who don’t have a million dollars. The numbers will not be greatly affected whether you have ten grand or a million. It will not affect these percentages, at least not in a significant way. Don’t let that be the number. We should have just said, “they took a lump sum of money.” In their study they actually use a million dollars as the amount. It wouldn’t affect it too meaningfully. They took the million bucks and then they basically did these tests like Ryan said where they took the million dollars and said, “let’s see what happens if we invest up from or slowly test it.” Then they did it over different periods. They invested it slowly over six months, slowly over twelve months, slowly over eighteen months, they kept doing it in six month increments. The longest period they tested was thirty-six months.

Ryan Isaac: Three years, ya.

Reese Harper: Twelve months was the most common assumption that they tested because that seems to be a good range of time that a lot of people end up picking as a time to incrementally invest. They tested the U.S market, the European market (exclusively London), and Australia. They tested those three stock markets, and they compared the balance of your account at the end of these different periods and tried to see if there was a percentage difference between the people who just put it in upfront and the people who layered it in. They also used different allocations. They mixed stocks and bonds. Some people who were 100% stock were tested and 100% bonds and different increments in-between too. It was a really thorough research study.

Ryan Isaac: I was going to say that, super thorough. The periods of time are called rolling periods. They were ten year rolling periods. They started in January of 1926 and go out ten years. They went all the way through 2011. There were like 1,021 different rolling periods. This is like a data nerds dream. Just sitting in front of this spreadsheet.

Reese Harper: Here is what happened, ok? First test, the U.S. test, basically on the U.S. test no matter whether you were 100% stock or 100% bond or any increment in-between, the lump sum investment beat the dollar cost averaging investment about two thirds of the time. About 2 out of 3 times, the lump sum investment is going to win. The same thing was true in the UK and Australia. It wasn’t statistically meaningful the differences between countries. Basically the study showed that lump sum investing was always higher. The probability of outperformance was always higher regardless of how you mixed the portfolio, or the timing of dollar cost averaging, or the market that you were in. The time period didn’t seem to matter, the market didn’t seem to matter, the percentage to stocks and bonds didn’t matter. The lump sum investment was always about two thirds of the time outperforming the dollar cost average.

Ryan Isaac: You know what is crazy about that, the only thing that did change that significantly over time, was the longer the dollar cost averaging took. So in that statistic where you said lump sum investing outperformed two thirds of the time, that was compared to a 12 month DCA time frame.

Reese Harper: Right.

Ryan Isaac: When that went up to the thirty-six month dollar cost averaging time frame, then lump sum outperformed 90% of the time. That is a huge difference. It is all attributable to the fact that no one can predict what the market is going to do, but eventually over time, things go up whether it is bonds or stocks. The longer you have cash sitting around that does nothing, the worse it is going to do over time. That is what was crazy. When it went to a three year period of dollar cost averaging it went up to 90% of time.

Reese Harper: I should clarify that. It does get progressively worse. The one statistic that gets worse, it doesn’t matter what market you are in, it doesn’t matter what you’re allocation is, it just gets worse the longer you dollar cost average. Spreading that over thirty six months is not as good as doing immediately or even twelve months. If you are going to dollar cost average, twelve months is better than three years. The actual performance difference, the actual percentages, if you take the balance at the end of each period and say how much bigger was the balance of my portfolio at the end of that period then give us those statistics, Ryan.

Ryan Isaac: Yes, exactly, I dream about them. The U.S was the highest, the U.S. had an outperformance of 2.3% on average. That means that the balance of your account was 2.3% higher than it would have been had you done the DCA approach. In the U.K. it was 2.2.%, and in Australia it was 1.3%.

Reese Harper: Let’s talk about how that translates. 2.3% higher in the U.S.? Let’s say roughly the balance is about 2% higher, on average. That is not going to kill my retirement, Ryan, if in one scenario I have got like three million dollars by using lump sums and the other scenario I have 2% less, so 2.9 million or something. It is a meaningful difference, but it is not like I should beat myself up over it if I am just really scared to do that, right? That’s what I am partially worried about and I want to make sure and talk about this in the next segment. When do I decide if I should be a lump sum investor versus a dollar cost averaging investor and what are some reasons why dollar cost averaging might make more sense, even though the statistics are showing us that lump sum investing is a better approach. Let’s take a commercial break, and when we come back, I want to talk about how this can apply to dentists in their portfolios.

Ryan Isaac: Ok, we are back from the break, Reese. Thanks for taking us through that post break chime, do you still do that?

Reese Harper: {chime} That is the C for Chi. I have now cleaned out this room of all negative energy, and I am ready to go back into the podcast. Let’s go back into this. How do we make all of this dollar cost averaging, lump sum investing stuff make sense for the average dentist, ok? What should I do about all of this? You tell me my balances are going to be bigger, you are telling me lump sum investing is better, and I am sitting on this asset that I sold, or I inherited some money from my great grandfather’s horse ranch. I used that example because that would never really happen to anyone, but me, maybe. There might just be a horse. I’ll probably just get an actual horse. The will would say, “you don’t get the money, he needs the horse.” I would be forced to ride it to work.

Ryan Isaac: Thanks grandpa. That is a provision in the will. He wants to teach you a life lesson that money cannot teach you, but only a horse can.

Reese Harper: I like it. Maybe you have just piled up a bunch of cash in the business, now you have got to decide if you should do lump sum investing. Ryan is telling me the data is there, so do I just turn over this million dollars I am sitting on all into stock? I think the short answer is, according to the data, yes probably. But here is what Vanguard can’t really test as easily. We do a presentation called “the five steps to better investment performance”. One of those steps is overcoming irrational investor behavior. One of the things that we worry a lot about is that regardless of what the data shows, if people can’t stick to a plan, then you shouldn’t move forward with investing. If you are not convinced that your plan will work, and you are not convinced that you can stick with it, then it may not make sense to invest in the optimal way. Sometimes the optimal way is the scariest, it is the most volatile, and you won’t be able to stick with it. That is where a good financial advisor comes in who can actually get to know you and have a good conversation about your net worth and spending and how much risk you can actually take before your ability to tolerate that just shuts down. They can also coach you, in most cases, a good financial advisor will help you be a little bit more tolerant of risk than maybe you would naturally be without any help or coaching. They can’t push you too far, or you will just quit your plan. One of the reasons we would say that you wouldn’t want to do lump sum investing has to do with this behavior issue, Ryan. Talk about that.

Ryan Isaac: Vanguard’s own words from the study said that, “risk averse investors, they might be less concerned about the averages, all of the data, then they are about worse case scenarios and the potential feelings of regret that would happen if their lump sum started to go down immediately after putting it in.” As an advisor, I would much rather have a client who slowly puts their portfolio in and sticks to that even if it is a over a long period of time and even if the data does tell us that the return might be slightly lower than a client who maybe gets talked into, or gets really excited about investing the money, and then as markets do they go down. That person can’t stick to a plan. Even in the face of statistics that tell us there is better return and a higher likelihood of a better return. I like the prospect of a better long term habit, something someone can stick to over a long period of time. There is some data in this study too that shows the risks that are being taken when you do a lump sum investment versus dollar cost averaging. Vanguard says in their study out of all of the rolling twelve month periods that they analyze, if you had done lump sum investment your portfolio, the lump sum investment portfolio, would have been down about 22% of the time, while dollar cost averaging investors would have seen declines at about 17.5% of the time. The losses are greater in the lump sum investments than they are on the dollar cost averaging because in dollar cost averaging there is so much money still sitting in cash. It is logical. There is risk with this. If it just so happens that your lump sum investment lands on the day before market decline or before months of market declines, than that can be detrimental to your behavior long term. That is much more important than hurrying and getting some money in because statistically it would get you better returns.

Reese Harper: I totally agree. That is a great summary of the choice between lump sum investing and dollar cost averaging. Lump sum investing is a scarier thing to do and it requires taking on more risk. There is a chance that you will bail on your plan and change your allocation. It happens quite often where people are in a volatile market cycle and they just want to change their allocation. They want to take some stocks out of their portfolio and add bonds because of how much they are going down. If lump sum investors make that choice and decide to put all of that money to work because they will end up with more over time, if you feel like you are that type of a person, then you just want to follow the data. Then you get into your two or three years into your lump sum investment and you don’t hold that same allocation. You get more conservative, you sell off some stock, and re adjust your portfolio to be less aggressive. You are going to be looking in losses that you won’t really recover from. Ryan and I would rather see someone who has a lot of apprehension or who is really conservative layer their money in slowly because they will still get a very good internal rate of return over that period of time over their investing lifetime. It is just that they don’t have the optimal rate of return on paper. The optimal would be lump sum investing. It is not that simple, however, and in many cases I choose to dollar cost average just because I know that based on the person’s age and ability to understand investment concepts, based on uncertainty of cash flow, uncertain about future purposes you have to make, dollar cost averaging just might be the only way that people feel confident enough to be comfortable.

Ryan Isaac: Here is the temptation. The temptation is that the fear from LSI comes from thinking
what if the market goes down tomorrow. I would say that if you know yourself well enough or your advisor knows you well enough, knows your habits, the rest of your situation, and how you would be affected if the market did go down after a big lump sum investment. That could be really rational logical grounds for doing dollar cost averaging instead. I wouldn’t say that it is rational to decide against lump sum investing because of a prediction or a guess on the market. You don’t want to turn on the TV or read an article, or talk to a friend that convinces you that because of some statistics or whatever piece of news the market is going to go down. You cannot avoid it because of a prediction of a crash, ya know? That is not a logical way to look at it. That is not a smart way. If you do decide not to lump sum invest because of previous personality and habits and interactions with money and investments or something else in your picture. That could be cash flow or liquidity, those are all logical reasons to consider just doing dollar cost.

Reese Harper: Ya, do you have any short term projects coming up with a level of uncertainty? How are you going to react mentally or emotionally to market volatility? I have a lot of clients in 100% equity and they have zero reaction to volatility. I mean, zero reaction. They have millions of dollars exposed to the equity markets and they are just like an iron trap on a bears leg in the middle of Alaska, during… I just made that up.

Ryan Isaac: During winter solstice and a what?

Reese Harper: The market is just crushing all of humanity and they are like taking a vacation, and are planning on a 42% decline in this anyway. They say, “I have got my portfolio tilted to small end value, Reese told me that I could potentially experience this kind of volatility. I will just keep investing money and buy stocks as they go down and continue to invest money during this cycle and I will make a lot of money on the upside.” Some people are like that. There are people that are on the opposite end of the spectrum, however. They literally forget that they had their money in the stock market and it is moving. It moves quick. They really struggle to deal with that volatility. Calling every three or four days just wanting to be reassured that things are ok. You just have to know yourself and know how you are going to react to volatility in the market. That will really determine lump sum investing versus dollar cost. Another question you brought up is what does the rest of their financial picture look like? Do they have a high savings rate? What does business profitability look like and growth? Are they caught up on their taxes? Any other investments or emergency funds in place? Is all of this money going to be put towards retirement? How much liquidity will they have left? How much time do you have before you need the money? All of these things are really great, I don’t know if you have any experiences with any of these that come to mind.

Ryan Isaac: Well, yes, you said taxes. I know that you have ran into this before where there is a big chunk of money and you tell them to throw it in there and then a couple months later the person is like, “oh, I have a tax bill.”

Reese Harper: You try to do as much research as you can on that to make sure that before you invest any money you are totally free and clear on all previous tax obligations. Sometimes people will be really behind though, and they will have like postponed filing for six months. They think they are all caught up and then they realize that they still owe $210,000. We didn’t know that when we started investing your money. Good thing we built an emergency fund with enough money to pay your taxes, you are going to need all of it!

Ryan Isaac: Yes, planning ahead for those type of things. You mentioned, for example, if you have a lot of money sitting around how do you know that all of it should go towards your investments? How do you know if you should pay off your debt to bring a big emotional/psychological benefit? You won’t know that unless you know if your savings rate is high enough. How do you know you can’t afford the boat? How do you know you can’t go on vacation? How do you know where the money is supposed to go unless their is a basic level of organization and clarity on other important subjects.

Reese Harper: I think it is important to be realistic about that stuff too. As financial advisors, we are not trying to make people’s lifestyle expenses be so frugal that they don’t enjoy their money. We get that some of you want a swimming pool. Some of you want a boat. Some of you want two houses. Some of you want to be financially independent at an early age, but you also want to take two nice vacations a year, and you don’t want to stay at the holiday in. We get that.

Ryan Isaac: Hey, shout out to the Holiday Inn though.

Reese Harper: I mean of all the chains to pick on in the mid market hotel brand, Holiday Inn is probably not the one to go after.

Ryan Isaac: Shout out to the Holiday Inn!

Reese Harper: I mean, they do breakfast for you sometimes, as I recall. I have stayed there. It is a happy place.

Ryan Isaac: It is happy.

Reese Harper: Ultimately though, what I am saying is, we understand that most of you have pretty big expenditures that you want to incur throughout your life just to live the kind of life you want to live. What a good financial advisor can do is really help you quantify some of those things that you really want to accomplish. Really quantify how you will achieve some of those goals whether they are lifestyle or they all wealth building or more trying to make work optional by building some retirement accounts and building your wealth through your investments. Whatever the goals are, and there will be some lifestyle goals. If you can quantify those and actually put a dollar amount towards those and say, “this is what these things are going to cost me.” The sooner you can quantify that, and with a time frame that that will happen in, then like Vanguard says in this report, “if markets are trending upwards, it is logical to implement a strategic asset allocation or a lump sum approach as soon as possible because it should offer a higher return than cash.” They are just trying to say, “look the longer you delay implementing an investment portfolio that gets cash out of your accounts and gets you exposed to the right investments, the faster you can do that the better.” You will have larger net worth and you will be able to enjoy those lifestyle things that you want to achieve at an earlier age as well because you will have your net worth compounding at a faster rate. I think it is as simple as that, Ryan.

Ryan Isaac: Ya, I think that’s a great place to wrap it up. I think if you are a dentist listening and you have a bunch of cash sitting around for whatever reason, ask some of those questions that Reese listed. Understand your taxes, savings, projects coming up, other investments, and ask those questions about putting a dollar amount to those things. You will need to quantify them and give them a time frame. I like the Vanguard advice you just ended with. Getting your money implemented as soon as possible. Which might not, for your temperament and personality, be a lump sum investment. As soon as possible might be twelve months, two years, or six months for you. But do it as soon as possible because the sooner it is exposed to a good asset allocation is better than leaving it in cash.

Reese Harper: The sooner that happens the sooner you can live in the land of C with Chi.

Ryan Isaac: Clear the Chi.

Reese Harper: It is. A good portfolio makes everything feel right. A good portfolio and confidence in your strategy will let you relax and enjoy life. As markets move you are not being thrown around emotionally as your net worth goes through some relatively unpredictable cycles. The more that you can just build a good portfolio and have it allocated properly you will be able to rest and enjoy the things that make your life more enjoyable.

Ryan Isaac: You’re Chi will be cleared and you will hear the note of C in your mind.

Reese Harper: C for Chi, yes.

Ryan Isaac: Alright well, we will end it there. That is enough C for Chi. Thanks Reese for the input and good discussion. Thanks everyone for listening. We have asked you this, but we would love if you would go to iTunes and leave us a review. That helps our podcast move up the search list. It helps more dentists find us. You can also catch all of these episodes of the dentist money show on dentistadvisors.com/listen. While you are on the site, if you would like to talk to us, there is a link at the top where you can book a free consultation with us. We are always happy to talk with you about your finances and questions that you might have. We will talk to you soon!

Reese Harper: Carry on!

Cash Management, Investing