We examine the historical performance difference between averaging into US equity exposure vs. going "all-in".
From its low on March 30, to the high it reached last Friday (4/17) the S&P 500 gained more than 13% and is now up a little over 4% for the year (through 4/22). Meanwhile, the Nasdaq-100 (NDX) has had an even sharper rally as it has risen more than 17% from its low. Given its speed, investors who didn’t get in before the rally started may have found it difficult to find an entry point as there were few, if any, pullbacks from the time the market bottomed to when it hit a new all-time high. And, if they have money to put to work, these people may now be reticent to buy into a market trading at all-time highs.
In this situation, it can be tempting to simply layer in exposure – it provides flexibility to buy lower if the market exhales. But while it may be a seem like an attractive option, unfortunately we usually pay for that flexibility in the form of lower returns. To illustrate the effects of layering or averaging in versus putting all your money to work now, we looked at two hypothetical scenarios for 10-year holding periods. We calculated the returns for both scenarios every month from January 1985 through April 2016, 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 April 2016.
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 April 2016.
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 over 92% of the time.
There were 376 months in our test period, giving us 376 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 376 observations, “All In” outperformed “Average In” 345 times. Said another way, out of the 376 starting points we looked and all the different market conditions that existed then, you would have been better off going “all in” more than 90% of the time.
Missing “the dip” is undoubtedly frustrating and putting money into a market trading at all-time highs can be uncomfortable. But, historically, you’ve been better to go ahead and put your money to work rather than trying to hedge your bets by layering in exposure.
