Should you take the plunge? Discover the benefits and trade-offs of phasing into markets

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 24.0% 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. 

To balance the trade-off between upside return capture and downside risk avoidance, using a phase-in period of no more than six tranches would seem to offer the best potential outcome.

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.

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

¹For purposes of analysis, our 60/40 stock-bond model represents allocations of 60% to U.S. equities and 40% to U.S. bonds.

²Source: J.P. Morgan, Bloomberg Finance L.P. As of 6/30/2024. Performance calculated using index returns for an allocation of 60% S&P 500/40% Bloomberg US Aggregate Index, rebalanced quarterly. While phasing in, excess cash is assumed to be invested in 1-3-month T-Bills. Back test begins on 12/31/1989, which is the extent of historical daily return data for the Bloomberg US Aggregate Index. Range shown is range of 5th to 95th percentile of observations, and middle line is median observation.

³For example, investing one third on January 1, one third on February 1, and one third on March 1.