|Investing a lump sum from a 401k Rollover|
I think we've all had the dream of getting a phone call or a letter in the mail informing us that we had some long lost rich uncle that just left us a huge sum of money after he passed away. Who wouldn't want to be in that situation? One day you're grinding away at work and the next you immediately jump up a few notches on the wealth scale.
Of course I think we should all take our financial future into our own hands by living below our means and investing the difference. That route has a much higher likelihood of success than hoping you have some long lost rich uncle out there. But one can dream, right?
You might not think you'll ever come into a large amount of money to invest although it's more common than you think. If you're doing the right thing then you're likely using a 401k or other workplace retirement savings program to save for your future.
Gone are the days of working at the same company for 30-40 years, getting a gold watch and calling it a day. The average person will work between 10-15 jobs in their lifetime spending less than 5 years in each position. If you're saving in your 401k and change jobs then you'll find yourself in the situation of how to invest a lump sum of money. According to Fidelity in June 2015 the median 401k had a balance just over $90k. To me that falls well into the lump sum category.
Since getting laid off I've been examining some options on where to move my 401k balance so I'm facing the situation of how to invest my ~$140k+ of assets.
How to invest my lump sum?
I'm debating 3 different strategies although they're really just different versions of the same thing. If you've been paying attention to my blog over the last couple months you've likely seen a large up tick in the amount of options transactions that I've been doing, primarily via selling put options.
I had gotten away from using put options as a way to generate income or buy shares at a discount. If done correctly you're essentially getting an opportunity to set a limit order and get paid until it triggers. Put options are a way to boost your income while buying quality companies, to me that's the best of both worlds for the long term investor.
Now there's no such thing as a free lunch and unfortunately put options don't escape that axiom. Although I'd venture to guess that if you stick to many of the dividend growth companies that we're all looking to buy the risk of permanent loss of capital is much lower.
Anyways let's get back to the task at hand.
Clearly I have a desire to use put options within my Rollover IRA. So I want to earmark at least a portion of this capital for the purpose of option writing to generate income. Originally my thought was to set aside about 50% of the capital exclusively for options.
The other half I was originally intending to keep in cash until we get something that really upsets the market. Regarding the market as a whole I think it's expensive; however, just because the market overall is expensive doesn't mean that there aren't values available it's just nowhere near as easy to find as a few years ago.
The values that I am seeing still aren't firesale prices, although those don't exactly come around too often when you're dealing with some of the biggest and most widely followed companies. That really only happens in the event of a market event. The values I'm seeing are more along the lines of the high end of the fair value range. So making purchases is defensible, but it's not the best deals we're likely to see.
Of course just because I see headwinds for the market doesn't mean that the market will cooperate on my time frame. I'd love to get this capital invested today IF I could find good values which is the big problem with keeping the cash on the sidelines in the hopes that the market will have a hiccup in a relatively short time period.
That's led me to consider other options...see what I did there?
My second consideration is a slight adjustment to Option 1 and would keep the 50/50 split between a more active options strategy and keeping cash on hand. Where it differs though is that the 50% that is earmarked for cash would be slowly dollar cost averaged into some of the best companies in the world.
That would still allow me to generate income/return via put options with half of the capital while simulatneously allowing me to build up positions. As I mentioned earlier I'm not naive enough to think that just because I see headwinds for the markets necessarily equates to it doing what I expect over a short time period.
The 50% that would be dedicated towards keeping a cash buffer while using dollar cost averaging to build positions for the long term works out to around $70k. If I made say $2k total worth of investments each month in $500 increments that still gives me around 35 weeks to get fully invested. So the cash wouldn't be "eaten" up too quickly and would still leave significant reserves to take advantage of any major market events. I mean we're still talking about 1.5 years to get half of that half invested if I do $2k per month.
Normally I wouldn't want to make such small purchases because commissions will be a big drag on each purchase. My broker typically charges $7.95 per trade so costs would eat up about 1.6% of the investment capital assuming $500 increments. Considering the big draw for investing on your own is that you can get costs much lower than investing via mutual funds/ETFs that wouldn't make since. However, when I rolled over my 401k my broker offered me 500 free trades so costs won't be a negative to making such small purchases.
The 3rd option is kind of an offshoot of Option 2 except I would split the funds up into thirds with 1/3 being used for options, 1/3 for a cash buffer and the final 1/3 used to DCA.
Originally I was leaning more towards Option 1; however, as time has gone on and I've given it more thought I'm leaning towards either Option 2 or 3, although those two are kind of one in the same.
In the case of a big decline in the markets cash is king; however, the big problem with that is that you never know when a market decline will happen. Yes, valuations are stretched, debt levels around the globe have been pushed to the limits, global growth is slowing, we're due for a recession, interest rates are set to rise...although this has been a concern for at least the last 2 years now.
That's the biggest drawback to waiting in cash for the markets to provide a big fire sale. You never know when it will happen. Plus you have to have the conviction to buy those companies in the midst of really troubling times which is much easier said than done. While I have no problem doing so, in theory, I've yet to be in a true bear market "world is ending" scenario during my investing "career" so I don't know for sure how I'll react.
I don't want to become completely preoccupied with the short term while neglecting the long term goal of this portfolio. So there needs to be a balance between both time frames and I think either Option 2 or 3 gives a good balance between the two.
Have you ever been in the situation of needing to invest a lump sum? Which of the 3 options do you think is preferable or do you have another suggestion?
Please share your thoughts below!
Image provided by Prakairoj via FreeDigitalPhotos