Get in the game

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  By Guest Blogger Sinan Terzioglu

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In 2024, the S&P 500 has made 57 new all-time highs, with only four years surpassing this number: 1995 (77), 2021 (70), 1964 (65), and 2017 (62). This is the second consecutive year that index has risen by over 25%. That happened only three times before: 1935-1936, 1954-1955, and 1997-1998. Currently, the S&P 500 is 25% higher than the average year-end target set by Wall Street strategists at the beginning of the year, leading some investors to question the sustainability of the gains.

Jim recently asked:

“My wife and I recently retired and sold our home. We plan to rent long-term and invest the proceeds from the sale. However, we’re hesitant to invest all our funds right now since the markets have performed exceptionally well and are at all-time highs. We’re considering waiting for a market pullback or dollar cost averaging in over a while. We’ve also seen in the news Warren Buffett’s Berkshire Hathaway sold a lot of equities and now holds a large cash position of over $300 billion. Given Buffett is being cautious we think its best to be cautious as well. What do you recommend?”

It’s tempting to take cues from an incredibly successful investor like Warren Buffett and Berkshire Hathaway, especially when they hold a large cash position. However, it’s important to recognize the significant differences between individual investors and Berkshire Hathaway, a massive conglomerate with diverse operations, including substantial insurance businesses.

These insurance operations need large cash reserves to cover potential claims and ensure financial stability. Additionally, over the years Buffett has made it known he is looking for “elephant-sized” acquisitions—large, impactful investments that require significant capital. This strategy is tailored to Berkshire’s scale and isn’t relevant to individual investors. Therefore, I recommend not taking cues from Berkshire’s asset allocation strategy when deciding how to deploy your capital.

While waiting for a market pullback might seem wise, I don’t recommend it. Timing the market is impossible, and many investors end up staying on the sidelines too long, missing out on valuable time in the market. As the renowned former Fidelity fund manager Peter Lynch once said:

“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in corrections themselves.”

A 2023 study by Vanguard found that lump sum investing outperformed dollar cost averaging about two-thirds of the time, primarily because equity markets have been positive roughly 75% of the years. The study analyzed the performance of lump sum investing versus dollar cost averaging over a one-year investment horizon for portfolios of 100% equity, 60% stocks/40% bonds, and 40% stocks/60% bonds. Vanguard concluded that in most historical market conditions, investors would have fared better with lump sum investing.

One key reason for the outperformance of lump sum investing is the opportunity cost associated with holding cash which was approximated by the 3-month US Treasury bill rate. When you invest a lump sum immediately, your money is exposed to the market sooner, allowing it to benefit from potential growth. In contrast, dollar cost averaging involves spreading investments over time, which can reduce the risk of investing at a market peak but also delays full market exposure.

Even if you agree that lump sum investing is sensible but are concerned about the market being at a peak, consider these insights from a 2020 JPMorgan study that analyzed data from the previous 30+ years:

“If you invested in the S&P 500 on any random day since the start of 1988 and reinvested all dividends, your investment made money over the course of the next year 83% of the time. On average, your one year total return was +11.70%.

Now, what do those figures look like if we only consider investments on days when the S&P 500 closed at an all-time high? They’re actually better. Your investment made money over the course of the next year 88% of the time, and your average total return was +14.60%”

In summary, choosing between lump sum investing and dollar cost averaging is never an easy decision. The key is to first develop a solid asset allocation plan that aligns with your long-term goals and risk tolerance. For cautious investors like Jim and his wife, lump sum investing is likely to yield the best long-term results. However, if this causes them to lose sleep, a hybrid approach—investing 50% now and dollar cost averaging the remaining 50%—might be the most optimal strategy for them.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.

Source: https://www.greaterfool.ca/2024/12/08/get-in-the-game/