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A few days ago, I had presented backtest results for investing a lump sum in one-shot into an equity mutual fund vs gradually. I had shown that those looking to reduce investment risk or looking for better returns via gradual investing will be disappointed as there was no clear trend as to which is better. In this post, I consider a sub-topic as suggested by Pradeep: When markets are at an all-time high, will there be any observable difference between lump sum and gradual investing?
Again, please note that, if you wish to invest a lump sum gradually because you are scared, then this post is not for you. This post is only for those who claim that gradually investing will lower investment risk and/or enhance returns.
So this is Pradeep’s exact comment: Sir, It’s a meaningful article. We see lump sums did well sometimes and gradual investing did well sometimes and no difference so many times. But one other perspective is, among those 467 data points, how many of those represented all-time highs (which is where we are today) and lump sum vs gradual for those points how did they perform? Similarly how many all-time lows, and how did they perform? Also from all-time highs, how many % of times markets went down and how many times it went up. This will give an idea of what is the risk at any all-time highs. Just another perspective applicable for today.
Now, I have taken the results from the previous study (please read this first): Investing a lump sum in one-shot vs gradually (STP) in an equity mutual fund (backtest results) and considered only all-time highs for the one-shot vs gradual investing comparison.
So the red dots represent all-time highs. The Sensex is shown here in log scale. To understand its benefit see: Are you ready to climb the Sensex Staircase?! Thankfully there is only one all-time low – the first couple of data points. So let us not worry about that.
The above graph also visually answers the second part of Pradeep’s comment: Most all-time highs are followed by further all-time highs. So to assume that the market will crash just because there is an all-time high is plain childish.
So now we compare one-shot investing vs gradual investing (over a few months) for different durations for investments made only during all-time highs. I have already shown in the previous study that there is no change in investment risk irrespective of when we invest and how we invest. So I will only show the XIRR(annualized returns) comparison results here.
Ten year investment period: one- shot vs 6 months gradual investment
The horizontal axis represents trial no. The gaps imply no investments were made between market-highs. So now, let us plot the return difference between lump sum and gradual investment.
When the return difference is positive (above black horizontal line), one-shot (lump sum) gave better returns. So all points below the black line correspond to when gradual investing was better. It is obvious that there is no clear pattern.
Ten year investment period: one- shot vs 12 months gradual investment
Ten year investment period: one- shot vs 15 months gradual investment
Five year investment period: one- shot vs 6 months gradual investment
Five year investment period: one- shot vs 12 months gradual investment
Summary
If the market is at an all-time high and if you have a lump sum, then invest it over a few months and be done with it. This is for your peace of mind. There is no evidence to suggest that gradual investing is better than one-shot investing at all-time highs or at any other time. Please do not assume what appears as common sense to you, will find quantitative support.
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M. Pattabiraman(PhD) is the author and owner of freefincal.com. He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Follow @freefincal “Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
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Dear sir,
Thank you for this informative article. This questions the logic and paradigm that are often unquestioned. I have just one doubt. Often, when all time high is climbed, PE is not very low. Then new all time highs may occur either with a reasonable PE (say 25). If all these data points are separated by the PE, will the inference be different?
Thank you for your insightful articles
The market need not correct just because the PE is high. And in any case it does not correct sharply. What matters here is the not the PE value at the time of investing but what happens latter. Since that anyway is unknown, the results should not be different. In any case all all-time highs are explored here
Spread it over 3 years or 5 years and you’ll start seeing why gradual investment reduces risk. Also it isn’t just about being better or worse than lump sum. Those investing at all-time highs are more worried about negative returns. So, comparing returns with similar investment in 10 year g-sec fund is more apt.
spreading a lump sum over 3 to 5Y! Now that is practical! Let us do that to prove that risk is lower!