How and When to Invest That Bonus Money
To invest or not to invest? That is the question. For financial professionals (private equity professionals, investment bankers, and asset managers) this question surfaces on an annual basis as bonuses are paid. After determining your saving priorities, a decision must be made about how to deploy the cash. Since bonuses and carry are such a large percentage of savings, this decision is an important one. You worked hard for that money and now you must determine how you can make that money work for you. Ultimately, the implementation occurs through one of the three strategies below:
Investing all at once can be a scary proposition, but research has shown this option is often the best of the bunch. Vanguard conducted a study concluding that investors were better off 68% of the time when investing all at once rather than systematically. Not only was it a better outcome, but the magnitude of outperformance was 2.3%! This approach takes a long-term perspective and trust in the marketplace but can lead to a great reward.
Although this language may be a bit foreign, you probably are already implementing this strategy today in your 401(k). This strategy invests cash into the market in pre-determined amounts over a pre-determined time period. This time period can be anywhere between 3 and 12 months but can be accelerated if there is a compelling opportunity to take advantage of, such as a market pullback. Dollar-cost averaging is a great strategy for those that may not feel comfortable investing all at once. The key to remember is that this is a risk reduction strategy, not necessarily a return-seeking strategy.
Don’t Invest and Wait for a Pullback
This strategy might sound the most appealing, but often leads to poor results and can create an issue of never getting invested. As an example, let’s say you just received a bonus at the beginning of 2013 and wanted to wait for a 10% pullback before investing. If this was the criteria, you wouldn’t have gotten invested until August of 2015 and missed out on more than a 38% return in the S&P 500. That lost opportunity and fighting against the natural tendency of the market can often lead to leaving return on the table.
The lumpy cash flow nature of the finance industry leads individual investors consistently addressing this question of when to invest their savings. Although there is empirical evidence of which strategy works, the decision ultimately comes down to comfort and relating back to the plan. Regardless of whether you decide to invest all at once or to dollar cost average, the key really comes down to defining the strategy and staying disciplined to ensure that you achieve your long-term strategic allocation.
Source: Vanguard. https://personal.vanguard.com/pdf/ISGDCA.pdf
Matt Kocanda is a Wealth Manager at BDF and a member of the Investment Committee. The investment committee develops BDF’s overall investment strategy. Matt focuses on advising Financial Service Professionals through their complex needs – including cash flow, tax, or estate planning. Matt received an undergraduate degree in Finance from Indiana University.