"All-in" vs "Average-in"
Consider a hypothetical scenario: Your client has just inherited $1 million and wants to invest half of it. What’s the best way for you to proceed? Should you invest it all at once or portion it out over time? If you invest the lump sum now and the market takes a sudden downturn your client won’t be happy. However, they also probably won’t be pleased if you average in over time, the market moves higher, and they miss out. So, what should you do? Won’t the results be dramatically different based on when you invest? After all, going all-in in February 2020 would have been a lot different than going all-in two months later.
To gain some insight into these questions, we looked at two scenarios for investing the client’s windfall for 10 years, an “All In” strategy and an “Average In” strategy. To mitigate the impact of time period selection (e.g., investing in February 2020 just before the COVID crash vs. in April 2020 just after the bottom) we calculated the returns for both scenarios every month from January 1985 through October 2015 (the last month for which we could calculate a 10-year forward return).
The “All In” Strategy - This scenario assumes you invested all available funds in the S&P 500 (SPX) at the beginning of the period. So, for example, in January 1985 all available funds would be invested in SPX for the next 10 years. We then calculated the returns for a hypothetical start date of February 1985, March 1985, and so on, through October 2015.
The “Average In” Strategy – This scenario assumes you invested an equal amount of the portfolio in the S&P 500 each month over the entire 10-year period. As with the “All In” strategy, we calculated the returns for the “Average In” strategy for hypothetical start dates at the beginning of every month from January 1985 through October 2015.
The results of our test are shown below.
Our test shows that, historically, going “All In” has clearly been superior to the “Average In” strategy. This may not be terribly surprising, after all, the market generally goes up over time, and with the “All In” strategy, you have the power of compounding on your side. What may be surprising, however, is the magnitude of the difference. On average, the “All In” strategy outperformed the “Average In” strategy by more than 75% on a cumulative basis. There was also a dramatic difference in the best performance for each strategy - going ‘All In’ in October 1990 generated a maximum 10-year return of over 370%, meanwhile the best return for the “Average In” strategy” was a relatively paltry 145%. Not only did the “All In” strategy generate higher average, median, and maximum returns, but it also produced positive returns more consistently, albeit by a slim margin. The “All In” strategy produced positive returns just under 92% of the time. There were 371 months in our test period, giving us 371 observations or hypothetical portfolios. Of these, only 28 produced a negative 10-year return. Interestingly, all 28 came in consecutive months from October 1998 through January 2001, near the height of the dot com bubble. The “All In” strategy also outperformed the “Average In” strategy with notable consistency – out of our 371 observations, “All In” outperformed “Average In” 340 times.
With over 350 observations it would be impractical for us to show the results for every hypothetical start date in our test. However, we have included a sample below that shows the 10-year forward returns for each strategy at the beginning of each calendar year from 1985 – 2015
In addition to a “windfall” scenario, these results may be relevant given the current market conditions. With stocks trading near all-time highs, you may have clients who are apprehensive about adding exposure; and while there’s no guarantee that the S&P will be higher next month or next year, historically, it’s usually better to go ahead and put that money to work quickly than it has to slowly ease in.
A few notes about our findings: our test looked at the results of investing in a lump sum vs averaging into exposure for the S&P 500 over a long time horizon (10 years). It should not be assumed that we would see similar results over a shorter period or for a different asset, like single stock exposure.
