Lump Sum Vs. Drip Feeding: Go All In Even When The Market Is Volatile
Investing in stocks leads to better returns in the long run even during choppy markets
Many people like to drip feed into equities during times of volatility, but look a little closer and the benefits aren’t what you may think. In fact, investors who used the strategy to avoid buying overheated stocks wound up faring worse than if they had gone all in right from the start.
The reason? The market goes up more than it goes down over time, so the risk of not being invested is greater than the risk of losses along the way.
To really understand the downside of drip feeding - also known as dollar-cost averaging - we need to look only so far as our own portfolios. Imagine you had taken the total value of all the money you’ve ever invested in equities and instead had made one lump sum purchase of stocks on the day you started saving, rather than over a period of years. Your money would be worth a great deal more, regardless of market conditions.
Check out the following example of a typical saver who ‘drip fed’ his savings into stocks over the last eight years. His $80,050 would now be worth $119,922, a return of 50%. Had he invested the same amount as one lump sum upfront, it would now be worth $188,828, a retrun of 136%.
Of course most of us don’t have the luxury of investing a lump sum early in our lives and instead accumulate our savings as we earn money, but it highlights the benefits of investing early and letting our cash grow for as long as possible.
We Are All Drip Feeders
Even if you don’t have a lump sum to invest, the drip feed drag is relevant to lots of other investment choices we make everyday.
Here’s an example:
Back at the start of August 2020 my investment club bought Sea Unlimited (SE), the Chinese gaming company, at $134 per share. I proposed buying 20 shares but the club wanted to tread carefully and so we bought 10 shares instead.
By September 1st, the stock had jumped 20.8%, to $161. Members were so impressed that we decided to buy another 10 shares, this time at $161.
Our return on SE fell from 20.8% to 10.4%.
10.4% is the blended average return of the original 10 shares (20.8%) and the 10 new shares, which had not earned anything yet.
September was not a great month for the tech sector. On October 1st, SE was trading at $160 - a shade lower than a month earlier.
Our return on SE was now 9.7%.
Again, this is the blended average of the original 10 shares we bought which were up 19.4%, and the second batch of 10 shares that were down 0.6%.
What if we had bought 20 shares back in August instead? What if we had not bought that second batch of SE shares and instead had bought another company? Hindsight is a wonderful thing, but more importantly it helps us understand how spreading out our investment can impact returns.
If we think about this in the context of our personal portfolios, it becomes more clear why drip feeding is not a winning strategy. Assuming we make solid investment choices that increase over time, the costs of not investing outweigh the impact of short-term market volatility.
Of course there’s an emotional side to investing, and drip feeding helps us deal with risk. There are also certain events that may mitigate taking the gung-ho lump sum approach; ie. if you have a shorter investment horizon and will need to withdraw in the next 5-10 years.
What If The Market Is About To Drop?
2020 is setting up to be one of the most volatile on record for the stock market. For long-term savers worried if now is the right time to buy stocks, there’s sanction in knowing it is.
A recent study by the Association of Investment Companies (AIC) in the UK found that investing a lump sum right before the worst market drops in recent history - the dot-com bubble in 2000 and the financial crisis in 2007– would have still been better than drip feeding.
The study compared the returns on a lump sum invested on the eve of the financial crisis in October 2007 through March 2020, versus the same amount invested as £50 per month over the same time period. The lump sum had grown 112%, whereas the drip fed account was only up 63%. The same held true for the dot-com crash: A lump sum invested in July 2000 right before the market dropped would today have grown 267%, versus 167% if it had been drip fed.
Investing a lump sum is better than dripfeeding the same amount over long periods of time (Source: thisismoney.co.uk; Association Of Investment Companies)
The key is the length of time – rather than the timing itself –before a lump sum outperforms other strategies. It may take a lot longer – to the tune of 20 years – but that’s an absolutely worst case scenario - the odds of which are unlikely any time soon. If anything, chances are the current market will continue its upward climb despite the volatility - albeit perhaps not at the same rate.
For those who plan on letting their savings build for at least 10 years or more, there is no better home for their money than the stock market. And for those who fear this isn’t the best time to buy into shares, it is heartening to remember the benefits will eventually come, at some point, down the road.