Updated: Jan 20, 2020
I've met a few prospective clients recently that have multiple six-figure sums of money sitting in cash. Each of them is concerned with investing a large amount into the market all at once and wanted advice on what to do. All of them are 7-12 years away from retirement, so the thought of having a volatile portfolio is not a pleasant one.
Here are a few things to think about when investing during all-time highs:
1. Mentally Separate Your Portfolio
When entering retirement, keeping 2-5 years of income in a combination of cash and bonds can help ease the mind when seeing the total portfolio go down. I talk about separating the different buckets of money as the cash market, the bond market, and the stock market vs. simply saying "the market." They are all different, and they all have different risks. I tell clients that their overall portfolio will definitely go up and down over time. However, that doesn't mean that we have to sell after their stock positions have gone down. We can pick and choose what to sell. Ideally, holding a few years of income in cash and bonds positions the client to be able to sell funds from the cash market instead of selling funds from the stock market after it's gone down. The stock market components of the portfolio represent longer term investments that we do not plan on selling/using for 10+ years - so it's really not a big deal if that piece of the portfolio goes down in the short term.
2. Here's What Happened If You Invested a Lump Sum Right Before the Past 4 Downturns
The topic of investing during all-time highs is one that I've been discussing with fellow fee-only firm owner and friend, Colin Overweg, CFP ® . He recently did a video regarding this topic, and it stemmed from a piece done by one of our favorite bloggers, Ben Carlson, CFA, titled: What if You Only Invested at Market Peaks.
Here is the summary - an investor saved his money in cash and then made lump sum investments right before the stock market suffered big declines. After the investments were made, the investor never touched the money again. The investments were made in: December 1972 (right before a 48% crash), August 1987 (right before a 34% flash crash), December 1999 (dot-com bubble; 49% crash), and finally October 2007 (Great Recession; -52%). The total amount that the investor invested was $184,000. Carlson's piece was published in 2014, and the investor's portfolio would've been worth $1.1 million at that time. How did that happen?! The investor still became a millionaire - he literally invested at the "worst" possible times. It's a testament that time in the market matters more than timing the market. The best quote from the piece is the following: "Losses are part of the deal when investing in stocks. How you react to those losses is one of the biggest determinants of your investment performance."
3. Retiring at 65 Means We're Still Planning for a 30 Year Time Horizon
When building income plans for clients, it's important to keep in mind that longevity risk is a very real thing. What if you live too long? The fear of running out of money is a major one for a lot of people. However, this has to be weighed against the fear of your portfolio going down in the short term. What if I told you that your feeling of safety when holding a large percentage in cash actually decreases your chances of plan success? Most plans need to take risk by being invested in the stock market because cash has risks of its own (inflation, taxes, etc.). When I construct financial plans, I have to make sure we're planning until age 90-95 and beyond. I get a lot of responses saying, "I won't live that long..." - however, I can guarantee that if I make a plan with income projections to age 95 and you live to be 90, it'll be better than making a plan with income to 90 and you living to age 95.
Mentally separate your portfolio - construct a plan that holds a few years of income in cash/bonds so that you have a plan for down markets.
Investing a lump sum before a market crash generally ends up being just fine - as long as you mentally separate the money. Knowing that the percentage of stocks will go up and down over time. Most of the time you're not investing all of the lump sum into 100% stocks.
You only lose money when you sell.
Holding a lump sum of cash generally decreases the success rate of the plan - it doesn't increase it.
If you're on the cusp of retirement with a lump sum of cash, it might be wise to look at your entire portfolio on a global level (meaning ALL of the accounts you have), to see what the true allocation is. If the level of cash on hand makes up 5+ years of income, one could argue that there is definitely room to invest a portion of the cash.
Even if you invest right before the market goes down, it doesn't mean the investor is dumb. It's part of investing.