A lesson of absolute returns versus ROI, and lump sum investing versus dollar cost averaging.
SO... A couple of months back, I saw a post.
I don’t remember what it was about exactly, but it had something to do with the returns of a private annuity being under 3.4% even if the person is in his mid-30s.
It wasn’t a fair example at all. Literally 5 – 10 minutes of research should have been able to find you a better plan that yields you more than 3.4% for an annuity.
Being a little furious curious, I decided to go and dive into some of the annuity plans I have access to, since as a Financial Advisor Representative (FAR) who offers multiple companies - I would be able to shop around and see whether or not I could beat the poor ROI example provided in that person’s article.
This was easily done.
But my joy at quickly establishing how much better private yields could be than the example were thrown off by something odd...
Single Premium Annuity vs Dollar Cost Averaged Annuity
Here's an example: $500,000 – as a single premium. The example, as mentioned, was at 3.4%. [All results are net of fees/charges etc]
Using my plan, the projected yield for the single premium was 4.15%, and the guaranteed rate was 2.15% - which was just excellent.
I’m always particularly happy about correcting misinformation, and I was all but ready to go about doing it.
Naturally, my colleagues questioned my good mood (I tend to get kind of loud when I’m in a good mood) and I told them about my discovery.
For context, Retirement plans are not my specialty. So one of my colleagues whose specialty IS in Retirement plans pointed out that it wasn’t even close to the highest annualized projected yield he’d seen.
I blinked. The plan I had chosen was already an upgraded plan.
Could it really go that much higher than 4.15% annualized?
I asked him which plans he was referring to, but he couldn’t recall the specifics.
“Try the 10 year one?” he suggested. “See what the annualized yield is like.”
I punched in keys for the exact same plan – all the while thinking to myself – I really don’t know what to expect here. Vanguard studies already show a lump sum has a higher annualized yield, with corresponding longitudinal studies since market goes up 2/3 of the time or more, insert technical jargon here, blah blah…
And surprisingly, this happened.
The guaranteed yield was significantly higher (2.38%), and the annualized yield was actually a little higher (4.19%).
Worse, I was told that this wasn’t even the best non-guaranteed yield in the industry right now.
Imagine if the client had been even younger – I bet over 4.5% would have been perfectly doable.
Wait, I realized.
Did DCA (Dollar Cost Averaging) just beat Lump Sum Investing?
[For what Dollar Cost Averaging is, read this. But it is basically putting in money at regular intervals instead of the entire lump sum at once]
My whole life is a lie!
…But of course not.
Once you put together the actual math, the return on the lump sum of $500,000 is 439%, while the $50,000 for 10 years is only 372% on total capital.
In other words: Lump Sum: $500,000 (4.15%) --- $2,193,580 10 Years DCA: $50,000 x 10 (4.19%) --- $1,844,383
What really fascinates me is how there’s such a sizable difference in absolute returns despite there being a small difference in the recorded ROI.
Even crazier, the small difference of recorded ROI was in FAVOR of the larger ROI, yet the absolute return was much larger for the investment with a small ROI since it was a lump sum.
In other words, a 4.15% return beat a 4.19% legitimately on paper.
How about Investments?
I wanted to make certain of this, so I did a little experiment.
As I subtly mentioned just now, the Vanguard study (https://personal.vanguard.com/pdf/s315.pdf) already demonstrated that lump sums tend to outperform Dollar Cost Averaging.
The Vanguard study is an often cited, very credible study due to its stringent methodology – compared to the limitations and criticism of something like SPIVA (insert link here), which is the go-to source to suggest that Active Mutual Funds fail to perform their indices (no duh).
For a specific illustration, lets look at the 20 year returns between 1998 and 2017.
I intentionally chose this 20 year period because despite 2017’s strong returns fresh in everyone’s minds, the high starting point of 1998 and having one of the longest bear runs in history (2000 – 2002, Dot Com Crash) puts Lump Sum Investing at a steep disadvantage since DCA helps you defensively.
From the above, you can see there there’s typically about 7 good years every 10 years (which typically fits the normal equity performance of 6 – 8 good years every 10 year investment cycle).
You can also see that the good performing years typically had far higher results than the bad performing years, which is also very carefully shown here in another article that I wrote recently. Using a capital of $400,000, the difference was massive.
Peng Jie, a colleague of mine - came up with the above illustrations. If you're looking for someone technical, he's your guy.
As for the results?
Lump Sum: $400,000 --- $1,101,940 [Result: 5.197% annualized] 20 Years DCA: $20,000 x 20 --- $826,607 [Result: 6.496% annualized]
On paper, the lump sum performed about 1.3% lower than Dollar Cost Averaging.
It also made almost Three Hundred, Thousand Dollars more. [$300,000]
So that's how a 5% annualized return beats a 6.5% one. Obviously, you know that it wasn't a 'fair' comparison despite the same amount of capital. But that should really illustrate how time in the market is better than timing the market, eh?
Not happy - sorry. That's literally how ROIs are presented and calculated...It's not my fault. :(
Whether you’re trying to invest or do a savings/retirement plan, these are really the key takeaways when you’re trying to make money in the long term:
1) Lump Sums still tend to win in the majority of situations...
…Even when a jackass Maverick stacks the odds against them.
Unless you’re a master trader, timing the market just doesn’t make sense at all if you already have the lump sums available. To quote the Vanguard study:
…This temporarily cash-heavy asset allocation is much more conservative than the investor’s true target allocation (the one that will exist after the DCA period) and that, while this short-term deviation from the target provides some relative protection from market downturns, it does so by sacrificing some potential for greater portfolio gains.
You can replicate this if you compare a yearly investment to a monthly investment as well.
Yearly will typically do better over time.
2) Don’t disregard a low yielding investment so simply – look at the absolute return and the overall big picture
This is important because we tend to write off low-yielding investments very easily just by looking at the number.
The context is very important, as I’ve demonstrated above where a lump sum outperforms despite being a whole percentage point lower in Return on Investment.
I am not intentionally trying to ‘cheat’ anyone’s feelings – in fact, most people already know that I enjoy selling long term investment plans paid across many years. So I don't exactly have much incentive to promote this.
But the reality is that ROI is calculated based on a certain set of criteria and it can be misleading and ill-advised to simply look at the percentage points. If you've kept away from the market, waiting for a crash and did better in terms of ROI, you still might not have done better in absolute returns.
3) DCA is really more of a short-term strategy, or for the especially cautious
That might seem like a controversial conclusion, but don’t take my word for it. I didn’t suggest it.
– Vanguard, the pioneer for index investing, did.
For those of you who are afraid of high prices or market crashes, you could start NOW with DCA. It would be better than timing when this crash hits, because it’s been predicted to crash since 2015 and seeing as that hasn’t happened yet, god knows specifically when it will.
Even Michael Burry, the fund manager who famously predicted the Financial Crisis and made $2.69 billion overnight – spent two painful years losing millions of dollars shorting the market before it finally happened.
But the evidence has already established that even if you do enter at a poor time, your absolute return is far more favorable than your delayed entries.
Don’t skip out on opportunities because of fear.
Investments are also available using CPF (Ordinary Account), SRS (Supplementary Retirement Scheme) and Cash.
Disclaimer: All returns and statistics posted on this article are not to be taken as investment advice. Any formal advice from my end can only be conveyed to you during a professional consultation.
**The Table Returns recorded above for the SNP500/QQQ do not account for the following
1) Dividend Withholding Tax
2) Forex Risk
3) Management Fees/Account Fees/Transaction Fees
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