Occasionally I get a question asking me what is better: Dollar Cost averaging or lump sum investing?
Maybe you just got a big bonus at work, or maybe you recently received an inheritance and are wondering what to do with it. When you start to think about investing it you might wonder:
Is it better to buy a little at a time or plunk in the entire amount and put it in all at once?
As usual, we are going to look at what the DATA and FACTS say!
So with all this being said the answer is not that simple. Why? Because that space between your ears (called the human brain), often gets in the way.
Our expectations of the outcome along with our hindsight bias throws most folks a curveball when it comes to making this type of financial decision
(1:00) Practical Planning Segment:
Based upon August 10th, 2020 article by Dimensional Fund Advisors. Click here to view the full article!
Understanding the relationship between expectations and results is crucial to experiencing peace of mind about investing. No matter what it is in life, expectations about the outcome of some event play a deciding factor in how we feel about the eventual outcome. If we never expect anything, then we are never disappointed. Realistically, however, it is clear that most of us develop expectations about nearly all aspects of our lives, and perhaps nowhere is this as pronounced and as potentially devastating as it is with investing.
The first way in which expectations may break down is known as hindsight bias. Hindsight bias is the tendency to believe that we knew all the time what was going to happen. An example of this phenomenon appears often in the world of sports–we know it as of Monday Morning Quarterbacking.
Learning the outcome of an event can make it easy to delude ourselves that we could have predicted the outcome accurately, before the fact. In postgame sports talk shows, the hosts and callers often appear to have convinced themselves that they knew, in advance, that a particular game strategy would succeed or fail. Endless hours are spent on the air second-guessing the coaches and teams because, in hindsight, these “Monday Morning Quarterbacks” have such a clear perspective of what the winning strategy should have been. Does anyone really believe these people had a clear idea of what the strategy should have been before the game? Of course not. Otherwise, one of these “experts” would have been hired as the coach.
You can see hindsight bias at play whenever you hear someone say, “I knew that was going to happen.” It is a commonplace tendency, and we’ve all done it. However, the fact of the matter is that none of us can predict actual outcomes in the future with any level of certainty. Only in hindsight does it become crystal clear.
Hindsight bias focuses on past events and lulls us into believing we had it all figured out. The phenomenon of hindsight bias is dangerous in investing because it sets up unrealistic expectations for the future.
So the lesson here is simply “Don’t do it”. Resist the urge of the self-talk that begins any sentence with the following:
“I told you so”
And “I should have”
“I knew the market was going to go up or I knew the market was going to go down.
“I knew so and so was going to get elected”
Quit lying to yourself!
“I should have bought that stock”
“I should have gotten out of the market” and that is typically followed by the “I Knew “ phrase.
The FINAL reality check for Hindsight Bias is that if you had really known what was going to happen, you would have taken different actions.
FOR EXAMPLE; If you really knew in advance that a particular stock was going to do well, you would (and should) have borrowed money to “bet the farm” on what you knew would happen.
Hindsight bias is an extremely dangerous human perception error because it leads us to believe that we have power and control and insight that we don’t – we cannot accurately predict the future.
Hindsight bias leads us to believe that we can win at Vegas, that we can pick all the best stock-pickers in advance, and that we can do all sorts of things that, in reality, we can’t do. When it comes to investing in the market, this is an especially dangerous belief.
Disclaimer: Please do not take advice from me on this show. As a licensed Fiduciary I am only allowed to give advice to clients. So unless you’re a client I can’t give you advice because I don’t know you. So think of this as helpful hints and education only. And please before implementing any information or ideas you hear on this show always consult your legal adviser, your tax adviser, and your financial adviser………….right? that’s just common sense.
“Opinions voiced in this recording are for general information only and not intended to offer specific advice or recommendations to any individual. All performance references are historical and no guarantee of future results. All indices are unmanaged and not available for direct investment.”