In last month’s article, I explained an alternative method of making investments into the stock market where fear of a possible downturn is at the forefront of an investor’s mind. Rather than investing all their money on one specific date, the money could be ‘phased’ into the market over a period of time (12 months in the example) – an approach called Pound Cost Averaging (PCA). Which of these two approaches offers the best return?

The above table puts those fears in a broader context. It shows the average annualised compound returns of the S&P 500 from 1926–2019. After the index has hit all-time highs, the subsequent one, three, and five-year returns are positive, on average. After the S&P 500 has fallen more than 10%, the subsequent one, three, and five-year returns are also positive, on average. Both data sets show returns that outperform those of one-month Treasury bills (a technical expression for cash). Overall, the data do not support that recent market performance should influence the timing of investing in stocks.

Both theory and data suggest that lump-sum investing is the more efficient and logical approach to building wealth over time. But pound-cost averaging may be a reasonable strategy for investors who might otherwise decide to stay out of the market altogether due to fears of a large downturn after investing a lump sum. Fear is a powerful emotion, so anything that can reduce fear, without significant detrimental effect, would appear to be a sensible approach for some.

The stock market has offered a high average return historically, and it can be an importantally in helping investors reach their goals. Getting capital into stocks, whether gradually or all at once, puts the holder in position to reap the potential benefits. A trusted financial advisor can help investors decide which approach – lump-sum investing or pound-cost averaging – is better for them. What’s clear is that markets have rewarded investors over time. Whichever method one pursues, the goal is the same: developing a plan and sticking with it.

November 2020