Investment strategies for large sums of cash

PHUKET: Consider the following investing dilemma: You have recently received a large sum of money (from a pension payout, inheritance, the sale of property or a business) and you want to put this money to work for you. However, interest rates and returns on what are considered to be the safest investments (for example US and European bank deposits and government bonds) remain extremely low while the stock market is well into a bull market with many investments having already seen large gains. What should your investing strategy with this lump sum be?

Obviously, you would be afraid of investing all of the money into the stock market just before a 2008 style market meltdown or bear market. However, there are ways to manage both your fears and your money.

To begin with, you need to consider how big this lump sum is compared to the amount of money you have in the form of cash or other investments. A good rule of thumb is if the lump sum is less than 20 per cent of the value of your total cash and investment portfolio, you should likely invest the entire amount into your existing asset allocation as it won’t impact it that much.

If the lump sum is more than 20 per cent of this value, you will need to consider one of the following investing strategies:

1) Pick a long-term asset allocation and put the entire lump sum to work immediately. This makes the most sense from a historical and statistical prospective as over time, stock markets eventually recover from bear runs and move higher. However, you may not sleep well at night if you are an overly conservative investor. Likewise, this strategy may be better suited if you are a younger investor who plans to continue working for a number of years, than if you are an investor who is already retired and living on a fixed income.

2) Dollar cost average (DCA) a small amount periodically over a set period of time. The benefit of taking a DCA approach is that it can be easily automated. For example, you have received $250,000 and you invest $10,000 a month spread over the next 25 months. The DCA approach does tend to be more effective than a lump sum approach in a volatile market where prices are moving up and down. On the other hand, the slow and steady DCA approach in a raging bull market will have you missing out on large stock market returns.

3) Value averaging (VA). A variation on the DCA approach, a VA strategy involves investing more money when the stock market is down and less when it’s up. Studies have shown the VA approach to be more effective than the DCA approach over time. The big problem with this strategy is that you will need to be very disciplined and hands-on as it’s difficult to automate and it won’t work in a strong bull market where the market keeps heading higher.

4) Staggered lump sum investing. This would be another variation on the DCA approach, but only with a much larger sum. For example: Let’s say you have received $400,000. For the next four years, you decide to invest 25% of the original lump sum into the stock market at the end of every year with the next tranche being in CDs or bonds that come due right before its time to invest in the stock market again. Had you done this at the end of 2007, 2008, 2009 and 2010, the first tranche would have gotten hit hard by the financial meltdown, but the next two tranches would have been invested at very good prices.

Investing a lump sum may appear to be a daunting task, but it can be done with peace of mind that will help you sleep at night. The global markets are currently experiencing a correction or transition to a bear (down-trending) market. This is normal after the strong advance from the 2008 lows in the US market and six years of gains. Corrections and bear markets eventually run their course and turn into bull (up-trending) markets giving great buying opportunities. Now is the time to prepare a watch-list of leading stocks and sectors to buy once the new uptrend begins.

Don Freeman, BSME is president of Freeman Capital Management, a Registered Investment Advisor with the US Securities Exchange Commission (SEC), based in Phuket. He has over 15 years’ experience working with expatriates, specializing in portfolio management, US tax preparation, financial planning and UK pension transfers. Call for a free portfolio review. Don can be reached at 089-970-5795 or email: freemancapital@gmail.com.