FINANCIAL MARKET UPDATE 10.27.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

LUMP-SUM VERSUS DOLLAR-COST AVERAGING

When thinking about market timing, the army of Robinhood day-traders is generally what comes to my mind first. There are, however, other more subtle ways one can engage in the practice. The temptation to time the stock market is strong, and even seasoned long-term investors and professional money managers can be induced into the activity.

A relatively benign form of market timing has recently increased in popularity. Many investors that may have ordinarily been comfortable investing a large lump sum are reconsidering due to election worries (we previously wrote about how the election might impact the market here and here). A popular alternative has been to make a series of investments, both before and after the election. This tactic is consistent with Dollar-Cost Averaging (DCA), which we will define as spreading what could be a large lump sum investment into smaller and similarly sized pieces, spaced out over a few regular intervals. For the purpose of this conversation, we have excluded investing a portion of earned income at regular intervals (such as typical 401k contributions). The purpose of the DCA approach is to avoid potentially investing the entire lump sum near a market peak. Is this a good strategy?

The math is clear on this topic, and it points to lump-sum investing as the superior route. Historically, the odds of the market closing higher on a given day have been slightly better than a coin flip (52%1). As the chart below illustrates, the odds of a positive return increase as the time horizon is expanded. With dollar-cost averaging, an investor is spreading the purchases out over time. Since the market tends to rise, investors tend to pay more for their subsequent purchases.

Historical Market Performance

Source: Dimensional Fund Advisors

While a spreadsheet will tell you the lump sum approach is the superior approach, people are not spreadsheets. We are all emotional beings, and for many, that emotion plays a role in investment decision making. In the 1970s, psychologists Daniel Kahneman and Amos Tversky developed a framework for evaluating how real people made decisions under risk. At a high level, they determined that people felt the pain of a loss more acutely than the pleasure of a gain by a factor of 2-to-1. This helps to explain why it is so common for investors to pay the opportunity cost of foregone returns while sitting on the sidelines in order to avoid the potential for the market to fall after making an investment. Dubbed “Prospect Theory,” the research has been credited with helping to start the field of behavioral economics and contributed to Daniel Kahneman winning the Nobel Prize in Economic Sciences in 2002.

As a baseline, we prefer the lump sum approach over dollar-cost averaging. In some circumstances, however, a DCA program may make sense. Sitting on the sidelines with a portion of investable assets is better than not investing at all. Additionally, while the market moves higher on average, it certainly doesn’t move higher all of the time. It is critical that the regret from investing before a sell-off doesn’t cause an investor to reverse their course and lock in losses. At the end of the day, the best strategy for an investor to take is the one they can stick with.

1. Data provided by Morningstar Direct. Based on the S&P 500 PR Index. Calculated using daily returns between 1/4/1928 – 10/26/2020

WEEK IN REVIEW

  • So far, 27% of S&P 500 companies have reported Q3 earnings results, according to Factset. 84% of these companies have beat earnings estimates, while 81% have beat on Revenue. The blended earnings growth rate for S&P 500 companies that have reported, combined with the estimates for S&P 500 firms that have not yet reported, sits at -16.5%. The growth forecast as of 9/30/20 was -21.0%, according to Factset. Despite the better than expected result thus far, the markets are down since earnings season began in earnest.
  • Data published by the Commerce Department this morning showed orders for long-lasting factory goods increased for the fifth consecutive month in September. New Orders for Nondefense capital goods (excluding aircraft), a proxy for business investment, increased by 1% in September versus expectations of a 0.5% increase. Business investment recouped its pandemic-related losses in August, according to the Wall Street Journal. According to the latest GDPNow estimate from the Atlanta Fed, GDP growth is expected to be 36.2% in the third quarter.
  • Other notable data releases coming this week include consumer confidence today, Q3 GDP and jobless claims on Thursday, and consumer spending, consumer sentiment, and inflation on Friday.

HOT READS

Markets

  • Pandemic Boom Stocks Don’t Have Earnings to Support Them (WSJ)
  • Millions Poised to Lose Unemployment Benefits in ‘Enormous Cliff” at Year’s End (CNBC)

Investing

  • Why Own Bonds When Rates are So Low? (Nick Maggiulli)
  • The 10 Worst Places to Get Investing Advice (The White Coat Investor)
  • Investing Legend Burton Malkiel on the Sell-Off: Sit Tight and Don’t Try to Time the Market (CNBC)

Other

  • Lots of Overnight Tragedies, No Overnight Miracles (Morgan Housel)
  • SpaceX’s Starlink Satellite Internet Service is Priced at $99 per Month, According to E-mail (CNBC)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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