Let’s say you find yourself with a lump sum of money.

Maybe it’s a small inheritance, a generous family gift, or a bonus from work. It could even be money that you’ve simply accumulated through saving and haven’t used yet.

Either way, at some point, many of us end up in a situation where we have a decent chunk of cash and we’re not sure how to invest it. Should we be investing a lump sum all at once, or slowly over time?

That’s exactly what we’re talking about today. Which is the right approach? What will produce the best outcome? And what else do we need to consider?

In this article, we’ll look at the various options for investing a lump sum of money. We’ll discuss the pros and cons of each method, and help you weigh up the right approach for your situation.

Why investing a lump sum can be a tricky decision

In truth, there are multiple approaches to this dilemma - and no perfect answer.

The pain of regret is what causes us much anxiety over this decision. We don’t want to feel like we’ve made the wrong choice. And we’ll feel this even more acutely if this is our first time investing a large amount, or if the funds come from an inheritance. This often makes things more complicated, emotionally speaking.

In practice, there are numerous outcomes that could lead to regret.

• We invest our lump sum all at once and then the market falls (the biggest and most common fear).
• We drip feed our money into the market, only for the market may shoot up quickly. We then regret not investing it all at the start.
• The market may fall slowly as we steadily invest in increments. It then falls even further after we’ve thrown in our last chunk.

As you can see, there’s a chance of regret no matter what we do. Welcome to investing! Of course, we can never know in advance what the best approach is going to be. All we can really do is use history as a guide, and balance that with what we feel comfortable with.

When a lump sum is best

Many experienced investors can make a strong argument for lump sum investing. And that’s because the numbers are on their side. According to data provider Market Index, the Australian share market has experienced positive returns in 81% of all calendar years since 1900.

Essentially, there’s a 4 in 5 chance that the market will be up in the year following your lump sum investment. In contrast, there’s only a 1 in 5 chance of ending the year in the red. Those are pretty attractive odds.

We can even take this a step further. The most common range of return for a 12-month timeframe is +10 to +20%. This means the market is more likely to deliver a decent gain than a modest one. I find that fascinating.

So, the lump sum argument is straightforward: invest as soon as you can, because the market tends to produce positive returns most years.

But critically, there are years where the market goes down. We’ll have to wait until 31 December to confirm, but it seems as though we’re experiencing one of those now! What this means is, if you’ve just invested a big lump of cash, you could feel some real stress.

Probabilities are great, but they’re of no comfort if they go against you. If that’s the case, you’ll wish you took the steadier approach of investing your lump sum over the course of a year or two.

When the drip-feed approach is best

The lump sum approach as described above could be seen as the more aggressive and potentially higher-reward scenario. The drip-feed approach, on the other hand, is more conservative.

Steadily adding money to the portfolio over a period of, say, 12-18 months is likely to provide a smoother and less extreme outcome. In fact, the drip-feed or Dollar-Cost Averaging approach can be thought of as a type of insurance. Why? Because on average, we are likely to receive a slightly negative outcome (relative to lump sum), but in return, we protect against the risk of a very poor outcome.

That doesn’t mean it’s not worth it. Not only are you likely to receive a smoother outcome from the drip-feed approach, but you get much greater peace of mind, knowing you're taking the lower risk approach. You also get to avoid the nightmare scenario of investing that lump sum into the market, only to see your portfolio get smashed over the next several months.

The stress of that happening could push you to sell your shares and retreat to the safety of cash to stop the pain. And that would make the situation even worse…because, if anything, we want to be buying if shares collapse!

As such, the drip-feed approach can make just as much sense for a few reasons.

Your personal situation and mindset

How do you know which approach to choose? Well, think about your normal investing behaviour. How do you react when the market falls? Do you just shrug your shoulders (since you couldn’t have known anyway) and keep investing your ongoing monthly savings?

This can give you a good indication of how you’ll feel investing a lump sum. Having said that, a lump sum can feel different, just because it’s a much bigger amount than we’re used to. Would the anxiety of making the wrong decision eat at you? Do you just feel more comfortable slowly putting your money in?

These questions should help you decide. What if you can’t choose? Well, one option is to do both. Invest half right away, and drip-feed the rest over a period of time. I’ve done this myself (being quite an indecisive person at times!), and I found it quite enjoyable.

One thing I will say is this: if you opt for the drip-feed approach, don’t drag it out too long. The longer you take to invest the money, the more likely it is that you miss out on returns due to the market's tendency to simply pay dividends and increase in value over time.

If you’re investing a lump sum, you’ll also want to be extra sure about what you’re investing in. By that I mean: do your research and decide you are definitely happy about the long term investment you’re making. To help with this, you might like to browse the most popular investment options on Pearler Explore, or by trying the new shares comparison tool.

Final thoughts

In essence, you want to strike the right balance between feeling comfortable with your strategy and the risk you’re taking; whilst maximising the likelihood of achieving good returns. Only you can decide where you sit on that spectrum.

Maybe you’re the cold, robotic, and unemotional type that can sit through fire and keep your steely gaze fixed on where the sharemarket will be in the long term. In that case, you’ll probably be happy betting that your lump sum turns out to be the winning play.

Or you might be the more cautious type; nervous about the possible downside and not wanting to risk such a large amount on a single purchase. If that’s you, then you’ll probably be more comfortable with dollar-cost averaging and drip-feeding your money into the market.

Either way, try not to worry about it - you’ll only know the perfect choice in hindsight! Remember: the main thing is that you’re investing that money for your future, rather than blowing it on other things. That’s the ‘big picture’ win to focus on, regardless of which method you choose for investing your lump sum.

Until next time, happy long term investing!