Today’s question comes from Sam in Cleveland, OH…
“What do I do with a previous employer retirement plan of approximately $60,000 that I want to roll into my current rollover IRA. In particular, do I invest the full proceeds in one shot, allocated however my money is currently allocated? Or do I dollar cost average over a specified time period?
The issue I see with one lump sum, is the same issue with any big lump sum of money – you run the risk of buying too high. But if you dollar cost average the rollover to slightly reduce risk, you then have a big chunk of money sitting on the sidelines for a while.
My previous employer sent a check [to cash out the 401k] as opposed to an in-kind transfer. I would really appreciate your thoughts.”
Matt & Joel’s response: This is a great question Sam, and we totally see why you’re hesitant to do a lump sum investment here. $60,000 is a lot of money and a large transaction.
But the reality is, you’re actually *not* doing a lump sum investment. Because those dollars were already invested in your previous 401k account!
Which means you’re basically trying to decipher whether you keep them all invested or not.
It’s a different predicament than someone who inherits $20k of *new* money or someone who gets a big bonus and wants to invest it all. The psychology and reality of this problem are different.
In your case, I’d stay fully invested. Here’s why…
Dollar Cost Average vs Lump Sum
There’s something distinctively different between DCA and lump-sum investing when you are deploying your hard-earned dollars into the market.
But the question for Sam here is whether or not selling any of his current holdings was on his radar before he started this 401k rollover process.
Sam might be worried that the market will see a bit of a pullback. And he might be right on that front. Currently, the market is close to all-time highs! But if he is worried, how would he figure out when and how to invest those dollars again? That’s an almost impossible conundrum. Nobody can time the market effectively.
The biggest potential gain would be if you were to dollar cost average into a long, drawn-out market pullback, paying slightly less for the index funds you previously owned. But the risk here is that you are too slow to DCA and your money sits idly by while the market continues to chug along. Again, nobody knows how long bear or bull markets will last.
The longer that happens the more reticent you’re likely to become, not wanting to stick with your original plan because you don’t want to invest at what you perceive as ‘the top of the market.’
Mathematically, lump sum investing usually wins over DCA. There’s an awesome calculator we’ll link to that runs various scenarios. Just enter the lump sum amount and time frame you would use if you DCA, and it’ll spit out the likelihood (based on market performance) of which scenario would work out better.
Sitting in Cash Too Long
Dollar cost averaging in this scenario can turn into a behavioral nightmare. That money would sit on the sidelines, missing out on gains, potentially for quite a long time. That’s the bigger risk if you’re asking us to play odds maker.
That being said, with interest rates where they are right now, money on the sidelines is doing better than at any other time in recent memory. I get why young folks are pumped about holding cash. 5% returns in your money market account feels great and is great! It’s lovely to see savers not being penalized.
However, the growth of the overall market clearly outpaces cash over the long run. Since Sam’s 401k rollover dollars are slated for “retirement”, it’s best to think long-term and invest all of that money ASAP.
When the market goes up ¾ of the time, I’d let that be my guiding light.
Time IN the Market vs. Timing the Market
On that note, I don’t know how old Sam is. But it sounds like he’s fairly young. So I think of this as a decision that will have minimal impact on returns over the decades.
Another reason not to try and over-optimize this: The S&P 500 will probably be at something like 45,000 in a few decades if historical trends continue. And it won’t matter much at all if you bought in at 5,500 or 5,600.
Being invested is the main key and driver of returns. As the old saying goes, time in the market means a lot more than timing the market!
The Bottom Line:
Since your 401k dollars are already invested, it makes sense to keep them invested and immediately drop them into index funds as soon as the rollover is complete. Even in a scenario where we’re talking about fresh dollars being invested, lump sum investing is still the best move.
Can we guarantee that it’ll work out to the greatest eventual net worth? Nope! But it makes the most sense given the reality of human nature and the history of stock market performance.
For the full version of this discussion, check out Podcast Episode #862 (it’s the second question in the episode)
Related posts:
