Feb 24, 2023
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 can be 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 likely occurs through one of the three strategies below:
Lump-sum investment
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 up to 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%!1 This approach takes a long-term perspective and trust in the marketplace but can lead to a great reward.
Dollar-cost averaging
Although this language may be a bit foreign, you are probably already implementing this strategy today in your 401(k). Dollar-cost averaging means investing cash into the market in pre-determined amounts at certain intervals. For example, many of us contribute a set amount to a 401(k) every month or pay period. The interval can be anywhere between three 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 might be 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 might lead to poor results and can create an issue of never getting invested. Take 2013 for example, which was the start of a strong period for the S&P 500. If you had received a bonus at the start of the year and decided to wait for a 10% pullback before investing, you wouldn’t have gotten invested until August 2015—and you would have missed out on a more than 38% return in the meanwhile.2 Fighting against the natural long-term rising tendency of the market can lead to leaving money on the table.
The lumpy cash flow of life in the finance industry leads many individual investors to ask when it is best to invest their savings. Although there is empirical evidence to support lump-sum investing, the decision ultimately comes down to comfort and relating back to your 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.
1 https://www.optimizedportfolio.com/wp-content/uploads/2021/03/vanguard-dca-taking-risk-later.pdf
2 https://www.macrotrends.net/2488/sp500-10-year-daily-chart
ABOUT THE AUTHOR
Matt Kocanda
Matt is a Wealth Manager at BDF and leads the Financial Professionals Practice Group. He is also a member of the Executive Team and serves as the Director of Growth. He serves as the personal CFO to families, private equity professionals, investment bankers, and asset managers. Matt loves to help make the complex simple and help clients enjoy a full life.
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