Category Investments

Investment research reveals phasing in outperforms a lump sum 40% of the time

20 March 2012 Jonathan Brummer of acsis

: In the current financial climate, consumers fortunate enough to receive a year-end bonus, or come across a surprise cash windfall, are faced with myriad investment options. Against this financial backdrop, many consumers are looking towards more risk av

According to recent research conducted on lump sum investing by acsis Research and Investment Management (RIM), phasing in only outperforms a lump sum approximately 40% of the time. This is based on comparing the returns of each approach after 12 months.

Brummer says that phasing in an investment reduces the downside risk of investing. For example, phasing in over nine months reveals that the worst 12-month return was -30% compared to -48% for a lump sum. “The risk reduction does, however, come at a cost. The research revealed that the maximum 12 month return is reduced from 125% for a lump sum to 88% when phasing in over 12 months, and the average return decreases from 16.91% for a lump sum to 13.01% when phasing in over nine months.”

He says that the acsis research also sheds light on the most favourable phasing in period. “It shows that there is very little difference in return when phasing in over three months versus investing a lump sum. If phasing in, a period of between six and 12 months should be used. As with any risk mitigation strategy, both risk and return will be reduced and a decision will need to be made as to whether the cost is worth it. The larger the size of the lump sum in relation to the total portfolio, the more important risk reduction becomes and the more sense it would make to phase in.”

Brummer also explains that because markets trend upwards, on average, phasing in will mean a lower return than a lump sum investment, as the investor is out of the market for a longer period.

He says that when phasing investments in over a period of time, investors need to consider the emotions that typically drive investment decisions. “Research has shown that investors typically react twice as emotionally to losing money than to making money. This behavioural bias is referred to as ‘loss aversion’ and means that most investors will take steps to protect themselves from ‘losing money’, even if this means that they could sacrifice a potential return in doing so.” He says that this reaction could be harmful for future returns.

“Unfortunately there will never be a ‘correct’ answer or formula when it comes to phasing in. The best an investor can do is to understand the consequences and emotions behind the decision and consult a financial planner when making these decisions,” concludes Brummer.

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