By Walter Updegrave
I have a substantial amount of cash I want to move into stock and bond mutual funds I already own. I'm aware of the concept of dollar-cost averaging, but I'm afraid that as soon as I move the money it will decline in value and take years to recover. My question is not about what to invest in, but how to make those investments timing wise. -- Robert P.
Dollar-cost averaging and timing aren't the central issues here. They're sideshows.
The real question is: Does the mix of stock and bond mutual funds you already own truly represent the balance of risk versus reward you're comfortable with as an investor?
If it is, then you should immediately invest the cash along the same lines your current investments are allocated. So if you decided that a portfolio of 60% stocks and 40% bonds is the right investment mix for your time horizon, then you should put 60% of the new cash into stock funds and 40% into your bond funds.
But if you're not okay with your current asset mix, then you need to change it to one that's appropriate -- and then immediately invest your new money in the same proportions.
I realize this isn't the standard advice you would get from many, if not most, personal finance journalists, advisers, talking heads on cable TV business shows and much of the blogosphere. The conventional answer would be to tout the supposed benefits of dollar-cost averaging and talk about the way it reduces risk or boosts returns or performs all sorts of wonderful magic.
But all of that is nonsense. Dollar-cost averaging is a clunky, inefficient way of investing. It's just been mindlessly repeated so many times that it's become dogma, which, as the late Nobel laureate Paul Samuelson once told me, is "a truth so truthful that we dare not question it."
But if you step back a moment and look at your situation from a slightly different vantage point, I think you'll see what I'm getting at.
While your fear of losing your money as soon as you invest it is understandable, you need to remember that you're already vulnerable to market declines. It's a natural consequence of investing. If the market tanks, the money you already have in stock and bond mutual funds will take a hit.
But you don't guard against that possibility by pulling your money out of your funds every time you're worried about a setback and then re-investing it when you feel better about the market. That's a recipe for selling low and buying high.
No, you protect against the risk of market setbacks by practicing asset allocation -- that is, you put together a mix of stock and bond funds that can generate decent long-term returns while keeping the downside to a level you can tolerate.
So what makes you think you should you do anything different with this new cash you're looking to invest? You shouldn't.
As for the oft-recommended strategy of dollar-cost averaging, or gradually moving your cash into your portfolio, say, by dividing it into twelve pieces and investing one piece each month, all you're really doing is taking a year to get to the asset mix you've decided is right for you. In short, you're undermining the investment strategy you've set.
So here's what I recommend instead.
Start by going over your current mix of funds and make sure that it truly reflects your tolerance for risk. The fact that you're so concerned about investing this new money makes me wonder whether you're investing more aggressively than you should.
I'm not suggesting that you huddle down in money-market accounts, bond funds or anything like that. But the key to investing is assuring that you're comfortable with your overall portfolio.
There are a couple of tools that can help with that assessment. If you go to Morningstar's Asset Allocator tool, for example, you can re-create your current portfolio and see how your investments might grow over different periods of time and get a sense of what kind of short-term setbacks you might suffer along the way. You can then try different mixes of stocks and bonds to see how they might perform.
You might also want to take a look at Fidelity's Portfolio Review tool. After choosing a goal and plugging in some info about your investments, you'll get a pie chart showing how you're currently invested, along with some stats showing the best and worst one-year return for that that mix as well as its average performance over the past 85 years. You can then use the slider to create more conservative and aggressive portfolios and see how they performed.
Once you're comfortable with the make-up of your portfolio, you can turn your attention to the cash you want to invest. And there the solution is simple: take the cues from the portfolio you've decided is right for you. No timing, no dollar-cost averaging. Just invest the cash into your existing funds in the same proportions they represent of your overall portfolio.
Following my recommendation doesn't mean the value of your investments won't decline if the market falls apart. But short of getting out of the market altogether (which then leaves you guessing about when to get back in) there's no way of avoiding that.
But going through the process I've outlined gives you your best chance of investing all your money, new and old, in a way that has a decent shot at getting the returns you want, while keeping risk at a level you can handle.