I'd Put Most of a Lump Sum Into an S&P 500 Fund Right Away. Here's When I Wouldn't.

The S&P 500 (SNPINDEX:^GSPC) set its latest record close, 7,818.93, on Oct. 6. As of this writing, it's just a little over 1% under that mark. For anyone with a lot of cash meant for an index fund, putting it all in so close to a record can seem like asking for bad timing.

The common alternative is dollar-cost averaging, which here means splitting the money into equal chunks and buying over several months. Vanguard tested the two methods in a 2012 study and found investing all at once did better around two-thirds of the time.

I ran a simpler check of my own going back to 1950 and got a similar result. So I'd lean toward putting most of the money in right away. But spreading purchases out still has a use, and it shows up in the bad years.

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What Vanguard found

Vanguard's study, called "Dollar-cost averaging just means taking risk later," compared both approaches over rolling 10-year spans in the U.S., the U.K., and Australia. The U.S. data covered 1926 through 2011, and the two other markets had shorter histories. In the main version, the waiting money was in cash investments and went into a mix of 60% stocks and 40% bonds over 12 months. Investing all at once won 67% of the U.S. periods, and the U.K. and Australia were at 67% and 66%. On average, the lump sum ended around 2.3% ahead in the U.S.

And the longer the money was spread out, the worse it did. Versus a 36-month plan, the lump sum won around 90% of the U.S. periods. The main reason is stocks and bonds have earned more than cash over time, so waiting money tends to buy in at higher prices.

Of course, the study was about a sum already on hand. Vanguard sees investing a piece of every paycheck as a separate case, since that money only comes a little at a time.

What about buying near a record?

Vanguard's main test mixed stocks and bonds, so I ran a stock-only version on the S&P 500. Using month-end closes since 1950, I compared investing a sum all at once to 12 equal monthly purchases. I valued each a year after the first buy, on price alone (without dividends), with the waiting cash earning zero.

Buying all at once won in 651 of the 909 rolling 12-month stretches, or around 72% of the time.

After all, the index itself gained in about three out of four of those stretches. Over the long run, stock prices have tended to follow company earnings higher.

Starting near a record didn't change things much, either. In the 247 stretches that began with the index within 2% of its record close, the lump sum won around 73% of the time.

Put simply, being close to a high hasn't been a reliable sign that a drop was coming. A record price doesn't say much about valuation by itself.

A money market fund paying interest in the meantime might shrink the gap. But Vanguard's study let the waiting money earn cash returns, and investing all at once still usually won.

Spreading it out pays off when a drop follows

Spreading purchases out has helped most in the bad years. In the 106 periods where a lump sum lost more than 10% over 12 months, the monthly buyer did better in 101 cases. The lump sum lost around 19% on average in those years, against about 10% for the monthly buyer.

October 2007 shows how far that goes. The index closed the month near its record, and a lump sum invested then was down around 37% a year later. Spreading that cash across 12 months still lost about 28%.

How would I put a lump sum into an S&P 500 fund now?

For money meant as a buy-and-hold investment, I'd put most of it in at once, using a fund like the Vanguard S&P 500 ETF (NYSEMKT:VOO). It trades around $707 per share as of this writing. Buying all at once has been the better option about seven times in 10, and the index sitting near its record hasn't changed those odds much.

But for investors who could sell in a panic if the index dropped hard right after they bought, spreading the money out arguably makes sense as insurance. I'd just keep it short. Vanguard's 2023 follow-up study suggested about three months for those investors, because every month in cash has a cost.

Spreading it out likely won't earn more money, but it can make a bad first year easier to sit through.

Daniel Sparks and his clients do not have positions in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.