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What should you do with your bonus?

May 28, 2015, 9:00 AM UTC
Money falling from briefcase of running businessman
Photograph by Gary Waters — Getty Images/Ikon Images

Let’s say you get a bonus. Or a tax refund. Or a modest inheritance. Whatever it is, it’s a nice chunk of change. And it’s not money you’re planning on using in the next five years, rather you’ve earmarked it: Future.

So what should you do with it? Put it into your portfolio, divvying it up in sync with your current (and of course, well-thought out) asset allocation? Or should you hold it on the sidelines and dollar-cost average it in over the next six to 12 months?

That’s a question Richard Graziadei, managing director at TIAA-CREF Trust Co. and his research colleagues posed recently. They looked at every 12-month period in the S&P 500 from 1926 (i.e. pre-Great Depression) to mid-2014, and examined asset allocations ranging from 20% stocks/80% bonds, to the reverse. The results: In most cases, putting the money to work right away turned out to be the right call. In a 60%/40% stocks to bonds mix, if you’d put the money to work immediately, the average return was 9.74%. If you had dollar cost averaged it in over a year, it was 5.17%. The difference on a $50,000 investment? Almost $2,300.

“This is not to say systematic investing is bad,” Graziadei points out. “It keeps you on track. It keeps you from doing something else with the money, and to a certain extent you are investing funds when they are available to invest. But if you’re going to get a bonus every January, would you rather put it to work or hold onto it and put 1/12th of it to work every month over the year [going all in is better].”

Financial advisor Carl Richards believes these two choices can be parsed to a spreadsheet answer and a human answer. “Because the stock market is up more on an annual basis more than it’s down, clearly the best time to invest money is when you have it,” he says.

Market volatility, however, can cloud one’s judgement. “The more volatile markets are, the more afraid people are to put in money all at once,” Graziadei says. And although market volatility has been tapering off since the beginning of the year, Federal Reserve actions on interest rates could bring it back. “The actual raising of policy rates could trigger further bouts of volatility,” Federal Reserve Vice Chairman Stanley Fischer said Tuesday in Israel, adding “but my best estimate is that the normalization of our policy should prove manageable for the emerging market economies.”

Your own reaction to volatility is something you should try to gauge before you push all your chips into the center of the table, Richards says. Behavioral finance – specifically the phenomenon of loss aversion – has taught us that we feel the pain of losing money twice as harshly as we feel the pleasure of gaining an equal amount. “Let’s say you wake up 12 months from now and your $10,000 windfall has become $7,000. What are you going to do?” he asks. “Don’t fool yourself. Think back to 2009 when your accounts were down. If there’s a chance the regret is going to be too much for you and you might pull the plug, then you should dollar-cost average.”

“To me,” Richards says, “dollar-cost averaging is not a mathematical tool. It’s an emotional one. Whichever way you decide to go, the really important piece is that you do it with awareness – that you do it on purpose.”