It’s a hot summer day. Standing at the pool’s edge, you feel torn between excitement and hesitation. The shimmering water looks inviting, but you worry about the 20-degree temperature differential between the water and air. Should you dive right in, or ease in gradually?

At the pool, this decision is low stakes. But with your investments, it’s pivotal.

When choosing how to invest money for the long term, you can either jump into markets all at once with lump-sum investing, or use a slower, systematic process known as “phasing in” or dollar-cost averaging. It’s important to consider the trade-offs of each. In this article, we assess various strategies for phasing into stocks and bonds and compare historical outcomes across different market environments.

The key is to balance the risk of a near-term market drawdown with the risk of missing out on potential upside by delaying your investment plan for too long. As our analysis shows, lump-sum investing may offer higher total expected returns, but phasing into markets narrows the range of possible performance outcomes, reducing volatility. 

Whether you choose to dive into markets quickly or take it slow, what’s most important is enhancing your ability to stay invested. Here, we take a closer look at how to optimize entry timing.

Evaluating the trade-off: Lump sum versus “phased-in” investing

The merits of long-term investing in stocks and bonds are clear: Historically, over 10-year rolling periods, a traditional 60/40 stock-bond allocation¹ has delivered positive returns 100% of the time since 1990, with an average 10-year return of 119%.² But the most nerve-racking part of getting into markets is the risk of experiencing short-term volatility.

It's important to remember that you will never be able to time the market perfectly. Historically, there is a 94% chance that an initial investment in the S&P 500 will be lower in value at some point even though the index has delivered an average annual return of 9.5% since 1928. And as you extend your time horizon, the chances of being “in the green” potentially increase.

But it’s also likely your investments will decline in value at some point, and this is where “phasing in” can help. This calendar-based, systematic approach aims to smooth out market entry points, limiting the effects of potential near-term market drawdowns while preserving the potential to capture upside.

The most common method of “phasing in” deploys cash to a specific asset class on a predetermined schedule, akin to paying rent each month. During a typical phase-in process, investors hold uninvested capital in cash or short-term investment vehicles, such as money market funds, to earn additional yield while waiting to move funds into their chosen long-term strategy.

The effectiveness of this approach can be seen below. This chart illustrates the historical results of phased-in approaches over different time periods for a hypothetical investor deploying capital to a 60/40 allocation. A three-tranche phase-in involves investing a third of the cash in equal increments over approximately two months.³ The same pattern applies to the six-tranche and 12-tranche approaches, with increments invested over periods of five and 11 months, respectively.

Unsurprisingly, the lump-sum investment approach for our model 60/40 allocation yields the highest median return of 10.0%. Since markets tend to go up over time, being fully invested for longer has been the most profitable choice, on average. However, the range of return outcomes for the lump-sum strategy remains the widest of all our scenarios, ranging from 24% to -9.8%. Again, this dynamic clearly demonstrates the trade-off: Compared to investing everything at once, a phased-in approach can narrow the range of potential return outcomes, even though it may lower your median return slightly.

How long should you take to phase in?

Over longer time horizons, the effects of the phase-in strategy type start to fade. Looking at annualized returns over three years, for example, the median return and range of outcomes for the 3-, 6- and 12-tranche options converge with those of the lump sum approach. However, extending the phase-in process too long – up to two years and 24 tranches, as shown below – leads to lower returns.

Adjusting your strategy to market expectations

So far, our analysis has covered a broad range of market environments. But what should you do if you expect a large equity market drawdown? To explore the impact of such drawdowns, we reran the scenarios, focusing on historical periods in which the S&P 500 experienced declines of varying magnitude in the first 100 trading days after the initial investment was made.

In our first drawdown scenario of -5% to -10%, which occurred in 17% of the periods we analyzed, median returns for the lump-sum and three- and six-tranche phase-in approaches were similar (8.3%–8.4%). However, the 12-tranche approach had significantly lower median returns, as markets often recovered before all 12 tranches could be invested.

In the second drawdown scenario of -10% to -20%, which occurred in 13% of the periods, median returns were positive across all approaches. Notably, all phase-in approaches outperformed the lump-sum strategy, with the six-tranche approach achieving the highest and best rate of outperformance: 92% versus the lump sum. In the -20%-plus drawdown scenario – a traditional bear market that occurred in just 5% of the periods we analyzed – the lump-sum median return turned negative for the first time. However, all phase-in approaches remained positive, as shown below.

Comparing different phase-in styles

While phasing in approaches may be optimal if markets decline by 10% or more in the first few months after you invest, it's impossible to know beforehand if this will occur. So what approaches should you consider if you have a bearish near-term equity market view? These two alternatives may be worth considering:

Fixed income first: If you’re investing in a multi-asset portfolio, you could phase into fixed income first. Below, we compare a standard six-tranche approach to a six-tranche approach that starts out by fully deploying cash into bonds (in the first three tranches), followed by cash to equities (in the final three tranches).

In a -20%-plus drawdown scenario, as shown, taking a “fixed income first” approach results in better median returns than a 12-tranche phase-in while still limiting downside.

But what if markets don’t actually fall by 20% or more? Over all time periods, the six-month “fixed income first” approach had a better median return than the 12-tranche phase-in strategy (7.7% versus 6.9%) and a stronger lump-sum outperformance rate (33% versus 31%). In our view, taking a “fixed income first” approach offers investors a preferable middle ground than extending allocations to 12 tranches.

Investor led: Some investors may prefer to take a discretionary approach to speed up or slow down their investment schedule based on market conditions. One common investor-led approach involves accelerating a standard, calendar-based phase-in approach if markets suddenly decline. Below, we compare a basic six-month calendar-based phase-in strategy with a six-month calendar-based approach that accelerates cash deployment as soon as the S&P 500 falls by 5%.

In our analysis, median returns were identical. Although it may feel better to invest quickly in the wake of a drawdown, market returns gained by taking this approach do not differ significantly from long-term averages. Past returns have little correlation to future returns, especially in the near term.

Conclusion: Balancing caution and speed

Our analysis clearly supports the familiar adage that time in the markets leads to higher returns than timing the market. Investing all at once may lead to higher returns, but it is also a likely to result in a wider range of outcomes than phasing in. If your first priority is to lower your portfolio’s range of return outcomes, you might want to consider using a calendar-based phase-in approach with six monthly tranches – or less. This approach can help reduce drawdown risk while ensuring that your portfolio allocation is invested quickly enough to benefit from potential future returns.

If you are especially nervous about the direction of equity markets, phasing in with fixed income first might be an option to consider. This approach can help reduce drawdown risk while ensuring that your portfolio allocation will be invested quickly enough to capture potential upside in the near future.

Re-entering markets with confidence

As you contemplate stepping back into markets, it's natural to feel apprehensive about short-term investment volatility. However, staying on the sidelines indefinitely can mean missing out on potential long-term gains. Systematically phasing into markets can help mitigate risks and smooth returns, allowing you to gradually build your portfolio allocation while managing volatility.

Reach out to your J.P. Morgan advisor today to discuss strategies for reinvesting cash and working towards your financial goals.

IMPORTANT INFORMATION

This presentation is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any securities or investment products. The information provided herein is intended to help you understand general investment concepts and strategies. It is not intended to provide specific investment advice or recommendations. Please consult with your financial advisor to determine how the information may apply to your individual circumstances and to develop an investment strategy that aligns with your financial goals and risk tolerance. The performance results presented herein are hypothetical and based on back tested data. Hypothetical back tested performance has inherent limitations and does not reflect actual trading or the impact of material economic and market factors on decision-making. The results are achieved through the retroactive application of a model designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. Past performance is not indicative of future results. Investing involves risk, including the potential loss of principal. Before making any investment decisions, please consult with your financial advisor to understand the risks and limitations associated with relying on hypothetical back tested performance. Imposition of performance fees would reduce the overall returns on your investment.

This material is for informational purposes only, and may inform you of certain products and services offered by private banking businesses, part of JPMorgan Chase & Co. (“JPM”). Products and services described, as well as associated fees, charges and interest rates, are subject to change in accordance with the applicable account agreements and may differ among geographic locations. Not all products and services are offered at all locations. Please read all Important Information.

Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.

Bonds are subject to interest rate risk, credit and default risk of the issuer. Bond prices generally fall when interest rates rise.​

Investors should understand the potential tax liabilities surrounding a municipal bond purchase. Certain municipal bonds are federally taxed if the holder is subject to alternative minimum tax. Capital gains, if any, are federally taxable. The investor should note that the income from tax-free municipal bond funds may be subject to state and local taxation and the Alternative Minimum Tax (AMT).​

The BVAL Muni Benchmark 5-Year is a financial index that measures the performance of municipal bonds with an average maturity of approximately five years. This index is part of the Bloomberg Valuation Service (BVAL) suite, which provides benchmark indices for various fixed-income securities.

This material is for informational purposes only, and may inform you of certain products and services offered by J.P. Morgan’s wealth management businesses, part of JPMorgan Chase & Co. (“JPM”). Products and services described, as well as associated fees, charges and interest rates, are subject to change in accordance with the applicable account agreements and may differ among geographic locations. Not all products and services are offered at all locations. If you are a person with a disability and need additional support accessing this material, please contact your J.P. Morgan team or email us at accessibility.support@jpmorgan.com for assistance. Please read all Important Information.