When is the best time to plant a tree?
In Montgomery’s last blog The Cost of Sitting in Cash, he pointed out the clear evidence that, for long-term investors, the best time to invest is now, and there can be a real cost to sitting in cash.
As some clients have asked how to best handle moving from cash to investing, below is a simple two-step process to consider.
Step 1: Consider Your Time Horizons
Start by considering your time horizons. If any of your cash may be needed for near-term expenses, or even unexpected expenses (i.e., your emergency account), it should not be invested. Period. Even though near-zero interest rates make cash unattractive from a return standpoint, stability trumps any potential for growth for these types of expenses.
However, once you have enough cash set aside to cover these shorter-term expenses, you could consider investing the balance towards your longer-term goals. The time horizon on these goals would typically be five to ten years or more into the future, and could include things like retirement, or longer-term purchases or education expenses. With this sort of time horizon, and taking a balanced approach to investing, you would have the opportunity to realize the more rewarding returns of the financial markets.
Step 2: Plan Your Entry
Now you must decide how you will actually move out of cash and into the financial markets. While Montgomery’s blog correctly points out that trying to “get it right” in the short run is not necessary and could even do more harm than good, could it make sense to gradually work that cash into investing instead of all at once?
A common approach to gradual investing is called Dollar-Cost Averaging (or DCA), whereby an investor spreads out their investment contributions in equal amounts over time. While this approach is most common when making contributions to one’s retirement plan (401k or IRA) over a working lifetime, it could also be used to invest a larger sum of cash.
To see if there is any value to taking the DCA approach for our purposes here, we could look at a recent article published by Dimensional Fund Advisors (DFA) titled Taking Stock of Lump-Sum Investing vs. Dollar-Cost Averaging. DFA concluded that, on average, investing in a lump-sum fashion is simply more productive than the gradual approach. The main reason for this goes back to Montgomery’s blog, and that is the fact that, over time, investing in stocks puts you in a position to earn higher returns than cash.
Having said that, there may in fact be times when a more gradual approach makes sense for emotional reasons. You have to be able to sleep at night. Maybe this cash was recently received as the result of an inheritance, or the sale of a major asset or business. Or perhaps the current world events around us give you pause in putting all the cash to work at once. Because the nature of investing is long-term, taking a gradual approach, while keeping the practical implications in mind, is a good approach to working towards getting your money invested and working for you.
Closing Thoughts – Advice from an Arborist
When frequently asked the question of “when is the best time to plant a tree”, a notable tree man is known for answering: “Yesterday!” Keeping our cash/seed in the packet will produce no fruit, and in fact, over time the seed may deteriorate. If our time horizon is long enough, the sooner we plant that seed/cash in the financial markets, the sooner we will be able to enjoy the fruits of its growth – invested prudently, of course!