Borrowing to dollar cost average

[Goanywhere]

Hi everyone

Our family are on the pathway to fire (roughly 3 years away) and like most others each month we studiously plow our savings into low cost index funds. Our annual savings rate is 80%.

The question I have relates to borrowing to dollar cost average.

To elaborate on this further, for various reasons 50% of my income is paid monthly and the remaining 50% as a lump sum at the end of that particular 12 months.  My income is relatively predictable and this final payment is not contingent on meeting particular hurdles etc and there is no risk of being laid off.

The impact of this is that our savings rate is 60% throughout the year, until of course the final month when the lump sum arrives.

Due to this, have been toying with the idea of dividing the final lump sum by 12 and borrowing that money to invest it monthly.  At the moment we can borrow at 3.39%

I guess my question is whether this is a good idea, is anyone else in a similar situation, and if not, would you consider this as an option?

Cheers
GA

[ixtap]

That seems like a pretty high rate to even try it at.

[bthewalls]

In my limited knowledge, I think I read once that dollar point averaging is great in declining market, but if market continues to trend up a lump sum now seemed advised.

Suppose we’re back to the old topic of market timing?

[cool7hand]

Notwithstanding the math, that interest rate is too high for us: meaning, we just hate borrowing. We'd just invest when the money comes in. While most people seem to worry about getting your money in at an opportune time to avoid losses, it's just as important to get your money in to benefit from days of unusual gains.

[theolympians]

"Due to this, have been toying with the idea of dividing the final lump sum by 12 and borrowing that money to invest it monthly.  At the moment we can borrow at 3.39%"


Are you going to make more than the rate plus any fees associated? With that, what investment risk is there? The market is up now will be until it isn't. Are you investing in individual stocks or something more historically stable like a mutual/index fund?

Again, is your investment going to exceed the amount you will be borrowing to pay to use a bank's money? Prepare yourself in the case the investment takes a dive.

You save ALOT. You are lucky enough to have a chunk of $ to invest at the end of the year. To me, random guy on the internet, that is good enough. I don't see a need to pay someone else to use their money to maybe eek out a little extra gain.

Your decision. Good luck.

[oldladystache]

I wouldn't.

[Radagast]

In my limited knowledge, I think I read once that dollar point averaging is great in declining market, but if market continues to trend up a lump sum now seemed advised.

Suppose we’re back to the old topic of market timing?

That is correct for a person who has a lump sum now, but wants to put it in slowly. OP is in opposite situation: wants to DCA in money now on a loan, and pay off the loan with a future lump sum. Putting money in ASAP is on average the best policy so long as the stock market is rising (which it has so far).

But, OP, I don't think it is worth the effort for your situation. The rate is moderate, but while returns will usually be higher, there will also be added risk. But what really kills it for me is additional time and complexity needed for the strategy.

[Goanywhere]

Thanks everyone, some very sound points.  I think with limited discretionary time -  "the juice really isn't worth the squeeze" so to speak.

What prompted this question, was my wife challenging me as to whether we were using enough leverage.  Where I'd got to was that we have a mortgage free house and asn index fund portfolio building nicely, so there is no need to move to a more riskier position but leveraging ourselves to invest quicker.

[theolympians]

They wife and I often have talks like this. We are both too financially conservative to actually do it. You are putting a ton of money away. I would count that as a win-- continue to do so, and see where you are at in 5 years. My guess is you will be happy where you will be.

Often we look for short cuts, an edge, anything that will get us where we think we want to go faster, and will make us feel smarter. Slow and steady wins the race. You are ahead of the pack already!

At my work, there are a few people who seem to dabble in trendy investment things, or are fast talkers with how they are investing; and can convince others to accept their investment advice. One of them admitted to me how much he had in his 403 account and it was only 50 grand more than I had. He had a few more years of service than me  to add to his balance, and was doing all this buying and selling in his account. I would argue that it didn't get him any farther than me.

With all this, as I wrote, I enjoy the thought experiments. You are winning as you are!

[talltexan]

If you're wanting more risk (and the accompanying higher return), then shift some of the current risky investments you have away from bonds, and put a greater share of the stock part into small-cap value funds

[FLBiker]

I agree -- at 3.39% I wouldn't do it.  At 1 or 2%, I might.  But you're doing great as it is, so I wouldn't sweat it.

[MustacheAndaHalf]

Due to this, have been toying with the idea of dividing the final lump sum by 12 and borrowing that money to invest it monthly.  At the moment we can borrow at 3.39%

Just to focus on this for a moment, I believe robinhood offers lower rates than that.  And I know Interactive Brokers charges 1.6% for the first $100k.  So there are better margin loan rates out there.

If someone was just starting to save for retirement, I'd suggest they try this approach until margin loans are too expensive - then stop.  For someone starting out, the earliest contributions compound the longest, so the margin loan cost on a year's contributions (each year) might be worth it.

For someone 3 years from FIRE, it doesn't make much sense.  Most of your investments have been compounding for years.  If you make the remaining 3 years of contributions half a year early, I wouldn't expect it to have much impact.

[ChpBstrd]

I'd frame the question less as a dollar cost averaging question and more of an issue where you are seeking to hedge yourself against possible increases in the value of the investments you will buy when your 12 month lump sum arrives.

In that sense, you are kind of like a corporation that has to buy commodities as an input into its processes. Because these commodities fluctuate wildly in price, and because the corporation needs a way to lock in a price so that they know how much they can sell their products for and how much capital to allocate to procurement, they use derivatives contracts to ensure they pay a predictable amount in the future for oil, corn, nickel, or whatever the commodity is. They are willing to suffer a small financial loss, on average, with each contract because they protect against a price spike that could wipe them out. On the other side of the derivative contract are commodity producers who likewise need to lock in a price so they can be assured that they won't get wiped out trying to sell their products at a market bottom. 

In your case, you need to hedge against the possibility that investment securities will be much more expensive when you receive your 12 month bonus than they are now when you are actually earning that revenue but can't spend it yet. You're considering borrowing the funds so that you can buy at today's price and eliminate the risk of having to buy the securities at a higher price later when your revenue arrives. However, this is offset by the risk that the securities will be priced lower in the future. These risks would seem to at least partially offset each other. It would be a wash if not for the tendency of stocks to rise over time.

Another possibility is to buy a call option, which grants you the opportunity, but not the obligation, to buy stocks or funds at an established price. These contracts have a value that deteriorates over time, and you pay this cost in exchange for the opportunity. With the call option, you'd only lose the much lower value of the call option if the market tanked or went nowhere. However, it's fair to say the price of the option contract reflects the market's average consensus equilibrium point and fairly accounts for the risk-adjusted expected future value of the contract. Like the debt you are considering, this would cost a single-digit percentage of the entire investment amount.

Mini-futures are a possibility if you are a particularly sophisticated investor, the amount you need to hedge is well into the six figures, and you're willing to watch the thing like a hawk.

TL;DR: Probably not worth worrying about.

[Goanywhere]

I'd frame the question less as a dollar cost averaging question and more of an issue where you are seeking to hedge yourself against possible increases in the value of the investments you will buy when your 12 month lump sum arrives.

In that sense, you are kind of like a corporation that has to buy commodities as an input into its processes. Because these commodities fluctuate wildly in price, and because the corporation needs a way to lock in a price so that they know how much they can sell their products for and how much capital to allocate to procurement, they use derivatives contracts to ensure they pay a predictable amount in the future for oil, corn, nickel, or whatever the commodity is. They are willing to suffer a small financial loss, on average, with each contract because they protect against a price spike that could wipe them out. On the other side of the derivative contract are commodity producers who likewise need to lock in a price so they can be assured that they won't get wiped out trying to sell their products at a market bottom. 

In your case, you need to hedge against the possibility that investment securities will be much more expensive when you receive your 12 month bonus than they are now when you are actually earning that revenue but can't spend it yet. You're considering borrowing the funds so that you can buy at today's price and eliminate the risk of having to buy the securities at a higher price later when your revenue arrives. However, this is offset by the risk that the securities will be priced lower in the future. These risks would seem to at least partially offset each other. It would be a wash if not for the tendency of stocks to rise over time.

Another possibility is to buy a call option, which grants you the opportunity, but not the obligation, to buy stocks or funds at an established price. These contracts have a value that deteriorates over time, and you pay this cost in exchange for the opportunity. With the call option, you'd only lose the much lower value of the call option if the market tanked or went nowhere. However, it's fair to say the price of the option contract reflects the market's average consensus equilibrium point and fairly accounts for the risk-adjusted expected future value of the contract. Like the debt you are considering, this would cost a single-digit percentage of the entire investment amount.

Mini-futures are a possibility if you are a particularly sophisticated investor, the amount you need to hedge is well into the six figures, and you're willing to watch the thing like a hawk.

TL;DR: Probably not worth worrying about.

That's a really good way of looking at it, and thanks for the effort put into write this out.    I'm going to keeper it similar and continue with our process.

[Goanywhere]

Due to this, have been toying with the idea of dividing the final lump sum by 12 and borrowing that money to invest it monthly.  At the moment we can borrow at 3.39%

Just to focus on this for a moment, I believe robinhood offers lower rates than that.  And I know Interactive Brokers charges 1.6% for the first $100k.  So there are better margin loan rates out there.

If someone was just starting to save for retirement, I'd suggest they try this approach until margin loans are too expensive - then stop.  For someone starting out, the earliest contributions compound the longest, so the margin loan cost on a year's contributions (each year) might be worth it.

For someone 3 years from FIRE, it doesn't make much sense.  Most of your investments have been compounding for years.  If you make the remaining 3 years of contributions half a year early, I wouldn't expect it to have much impact.

We aren't in the US so don't have access to such cheap credit through the likes of Robinhood etc.  3.3% is the absolute best available.