How to invest a lump sum

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wisdomseeker
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How to invest a lump sum

Post by wisdomseeker » 31 Aug 2017 12:22

I have an amount (about 150k) to invest. The money is in a RDSP (Registered disability savings plan) so I do not have to worry about taxes.

I do not feel comfortable investing all the money at once when stock prices are so high. I feel more comfortable with dollar cost averaging. I am just starting to read on this topic. Some research indicates that it's prudent to invest a lump sum immediately and that I cannot predict when stocks will go down.

I am curious to find historical data concerning how an investor who invested a lump sum prior to a crash did with his investment over time if he stayed in the market for a long period of time (15-18 years). I would be curious to see what his rate of return would be.

What are your thoughts on this topic and can you provide any research concerning the question I asked above?

Thank you!

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Re: How to invest a lump sum

Post by Peculiar_Investor » 31 Aug 2017 13:09

In case you haven't yet found it, we have a wiki article Dollar cost averaging - finiki, the Canadian financial wiki that helps to address your question. The Further reading section provides some links back to previous FWF discussions.

Also, from the research point of view, in the External links section is a worthwhile read (IMHO) Dollar-cost averaging just means taking risk later | Vanguard Research which summarizes the choice and the behavioral aspects well:
Vanguard Research wrote:We conclude that if an investor expects such trends to continue, is satisfied with his or her target asset allocation, and is comfortable with the risk/return characteristics of each strategy, the prudent action is investing the lump sum immediately to gain exposure to the markets as soon as possible. But if the investor is primarily concerned with minimizing downside risk and potential feelings of regret (resulting from lump-sum investing immediately before a market downturn), then DCA may be of use. Of course, any emotionally based concerns should be weighed carefully against both (1) the lower expected long-run returns of cash compared with stocks and bonds, and (2) the fact that delaying investment is itself a form of market-timing, something few investors succeed at.
The part that I've bolded seems to address your comfort level issue.

If you are going to dollar cost average (DCA), then I suggest picking a time period, say 12 months and then commit to making defined investments at specific intervals, such as one quarter of the amount every 3 months or perhaps one-twelfth of the sum monthly.
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Re: How to invest a lump sum

Post by longinvest » 31 Aug 2017 16:56

wisdomseeker wrote:
31 Aug 2017 12:22
I have an amount (about 150k) to invest.
...
I do not feel comfortable investing all the money at once when stock prices are so high.
My opinion is that the target asset allocation should be reconsidered. The allocation to stocks should be lowered to a level where investing the lump sum becomes emotionally bearable.

I don't believe in valuations; those who got completely out of the market in 1997 missed on a lot of additional growth. So, I pick an allocation with enough exposure to stocks to harvest part of their growth, and enough bonds to cushion the drops. The portfolio must be permanently ready for bull, bear, and sideways markets.
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Re: How to invest a lump sum

Post by 2of3aintbad » 01 Sep 2017 11:24

Historical studies will give you a probability for a particular investment (stock, index, asset class, etc.), and over a number of such lump sum investments over your lifetime, your experience will approach that probability. If you were investing for your own benefit, such as in your RRSP, your choice might be different than if it were for someone else's benefit. (Is the RDSP for you or for someone else?) Are you planning to withdraw regularly from the plan?

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Re: How to invest a lump sum

Post by Mouly » 01 Sep 2017 12:03

The few times I have been in this situation I have also gone the lump sum route. My thinking is if I'm not comfortable buying all at once then why am I considering this stock at all? But also I am investing for long term and income, so I want the full income to start right away. I could DCA it over a period of time when the price was flat and then it could slump anyways. Then I'd be in the same position as a lump sum purchase but I wouldn't have had the income.

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Re: How to invest a lump sum

Post by wisdomseeker » 01 Sep 2017 12:04

Thank you for your responses.

Peculiar_Investor, I really enjoyed reading the article "Dollar-cost averaging just means taking risk later"

longinvest, thank you for your post. I was also thinking about changing my asset allocation and including a much higher percentage of bonds in my porfolio.

The RDSP is for me and if I withdraw money from my RDSP before the age of 59, there will be a severe financial penalty so I am hoping to be able to avoid taking any money from my RDSP for some time (I am 40)

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Re: How to invest a lump sum

Post by OnlyMyOpinion » 01 Sep 2017 16:14

WS, I think most of us have faced the same challenge. There can be a lot of mental anguish at play when committing large lump sums to an investment, particularly if it is not something you have the good fortune of doing regularly.
You don't mention what investment(s) you have in mind?
I know I find it 'easier' when the investment is a diversified etf or decently ranked MF because I am effectively investing across multiple companies or bond issuers. Sure I still face the cyclical risk of a market correction but I can accept that for a long term hold.
Perversely, it can be easier to commit smaller amounts to a single stock which carries both cyclical and fundamental risk.

You asked about historical data or results. Here is a link to a calculator that provides some insight. You may want to use it in conjunction with a historical graph of the S&P 500 and pick some best and worst months to get a sense of the extremes (e.g. a lump invested Sept 2008 would have been nasty):

http://www.moneychimp.com/features/dollar_cost.htm
.
Last edited by OnlyMyOpinion on 02 Sep 2017 14:07, edited 1 time in total.

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Re: How to invest a lump sum

Post by BRIAN5000 » 01 Sep 2017 18:58

http://www.efficientfrontier.com/ef/997/dca.htm
"I am a strong believer in the advantages of DCA (dollar-cost-averaging). I recommend it to anyone making a substantial move from cash to mutual stock funds (unless they fancy themselves to be market-timers). In particular, if you have recently received an inheritance that increases your worth by over 50%, you should use DCA instead of putting it all in at once. If you have a large amount of money that you know you really ought to put into the stock market but you can't bring yourself to do it because you are afraid the market is too high, you should use DCA for 12 months instead of waiting."
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Re: How to invest a lump sum

Post by longinvest » 02 Sep 2017 09:04

BRIAN5000 wrote:
01 Sep 2017 18:58
http://www.efficientfrontier.com/ef/997/dca.htm
"I am a strong believer in the advantages of DCA (dollar-cost-averaging). I recommend it to anyone making a substantial move from cash to mutual stock funds (unless they fancy themselves to be market-timers). In particular, if you have recently received an inheritance that increases your worth by over 50%, you should use DCA instead of putting it all in at once. If you have a large amount of money that you know you really ought to put into the stock market but you can't bring yourself to do it because you are afraid the market is too high, you should use DCA for 12 months instead of waiting."
I disagree with this Boiling frog approach. If one is unwilling to accept the risk of his target asset allocation by dumping everything into it, it makes no sense to do it over a longer time frame. It is simply illogical (and quite dangerous from a behavioral point of view).

Every time we hold a portfolio without selling part of it or adding to it is equivalent to selling the entire portfolio and buying it right back for the same price (and no transaction fees or taxes). In other words, by doing nothing, we are effectively deciding to keep the same asset allocation.

Using DCA instead of adding a lump sum to a portfolio is equivalent to changing the asset allocation to ease back slowly into it, like a boiling frog. While it might feel better, it offers no protection whatsoever against stocks crashing just at the end of the DCA period. If one is unwilling to accept the full risk of his target allocation, the solution is to change the target to something bearable.

Lump sums are actually an awesome tool to help better assess our difficult-to-discover willingness to accept risk. It's easy to blindly accept more risk than we think by investing in small increments. We tend to only concentrate our attention on each small contribution; as a result, the risk seems small. We think: "What if I lost 50% of this $500 I'm investing? I would temporariliy lose $250. I make many times that each months! Anyways, I would get the opportunity to buy stocks on a rebate. OK. Let's go with it!". We forget that we are, in fact, deciding to (re-)invest the entire portfolio into that same allocation.

The danger from a behavioral point of view (mentioned in my first paragraph) is to discover our unwillingness to accept as much risk after the fact, after stocks have crashed and we've lost more than we were willing to lose. Lots of people discovered their effective willingness to accept risk in 2008-2009 and reacted in a self-destructive manner. Some got out of stocks entirely. Others, with some allocation to bonds, simply stopped rebalancing their portfolio; they were willing to buy stocks at high prices a few months earlier, but unwilling to buy more at a 50% rebate! "Buy high, sell low" is not a good investing recipe.

Beyond our hard-to-discover subjective willingness to accept risk, there's our objective capacity to assume the consequences of a bad outcome. In 2008-2009, what caused many U.S. workers to sell some of their stock holdings at a rebate was that they lost their job and needed the money to pay their mortgage. They didn't sell because they were afraid of stocks, but because they had no alternative.

In summary: I think that resorting to DCA is indicative of a dangerous behavioral pitfall.
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Re: How to invest a lump sum

Post by OnlyMyOpinion » 02 Sep 2017 09:57

I invest lump sums when I have them. Without knowing the future, that's what makes sense to me.
But frogs aside, if we are talking strictly about the concern and inertia involved in investing a one-off lump sum into the market these days by someone who is otherwise willing to be invested for the long term - a 12 month purchase program to alleviate that concern and get the money working for you can be a solution.
It can make sense and it does offer some protection against stocks crashing. It certainly not a pancea for someone who otherwise is not prepared for the market.

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Re: How to invest a lump sum

Post by Quebec » 02 Sep 2017 10:04

longinvest, I find your post very insightful. I've added this FWF topic to the finiki article on DCA, which is currently incomplete. Please consider editing the DCA article, or creating a new ''Lump sum investing'' article. Other editors will help.

Regards, -Qc

=============

ADDED LATER: the goal being of course to produce a balanced article for finiki. E.g. DCA offers psychological benefits.
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Re: How to invest a lump sum

Post by longinvest » 02 Sep 2017 12:50

Quebec wrote:
02 Sep 2017 10:04
longinvest, I find your post very insightful. I've added this FWF topic to the finiki article on DCA, which is currently incomplete. Please consider editing the DCA article, or creating a new ''Lump sum investing'' article. Other editors will help.

Regards, -Qc

=============

ADDED LATER: the goal being of course to produce a balanced article for finiki. E.g. DCA offers psychological benefits.
I added a section about behavioural pitfalls. Feel free to improve it, including fixing any incorrect usage of Canadian English (e.g. behaviour vs behavior).

I'll let others write about so-called psychological benefits(???). (I don't believe in them).
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Re: How to invest a lump sum

Post by OnlyMyOpinion » 02 Sep 2017 18:13

Adding to the dog frog stew, taken from the link I provided earlier:

"some people also think you should dollar cost average a lump sum. For example, if you had $12,000 that you wanted to invest in a stock index fund, they would tell you to invest $1000 per month over a year, rather than investing the whole amount immediately. The rationale is that market volatility should then work in your favor, because you will automatically be purchasing more shares when the price is low, and fewer shares when the price is high.

As appealing as that theory is, its advantage looks like a myth, as this calculator shows. It uses market data to let you compare dollar cost averaging with lump sum investing for the start date you specify.
< >
Each strategy wins at least some of the time, but after a few runs you'll see that DCA is the statistical "dog", losing about two times out of three.

Of course, dollar cost averaging will win if your start date falls right before a dramatic crash (like October 1987) (*added - or Sept 2008) or at the start of an overall 12 month slump (like most of 2000). But unless you can predict these downturns ahead of time, you have no scientific reason to believe that dollar cost averaging will give you an advantage.

So why do so many people persist in believing that this old dog really knows how to hunt? Maybe because it has a psychological appeal: if the market dips, people will be happy because DCA will be saving them money; and if the market goes up, people will be happy regardles"


Still, if it takes the psychology of DCA to get your lump sum invested, then it has merit IMO.

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Re: How to invest a lump sum

Post by longinvest » 02 Sep 2017 18:36

OnlyMyOpinion wrote:
02 Sep 2017 18:13
Still, if it takes the psychology of DCA to get your lump sum invested, then it has merit IMO.
The thing is that the average allocation over the period is 50% in stocks, 50% in cash. Why not invest the money, instead, into a 50/50 portfolio from the start? Why push the client into a higher stock allocation than he is willing to invest into?

The cynic in me thinks that the objective might be to maximize the probabilities of collecting more in fees from assets under management (AUM), due to the higher probability of stock outperformance. The financial advisor doesn't experience the full consequences of a bad outcome, so he cares much less about them. Stock funds might carry higher trailing fees, too.
:twisted:
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Re: How to invest a lump sum

Post by flywaysuzy » 02 Sep 2017 19:34

WS, if it was me, I would set a goal: have all this money out of the cash account by Dec. 15. Figure out how much of the total you want in fixed income, gics or? Do you want the rest in stocks or ETFs? If stocks, I would find 10 stocks to make up $100k ( if that was my equity amount) if Etfs, find 5 or 6. If you are looking to buy good quality dividend producing stocks, they are probably not going to fluctuate large amounts between now and December, so make your list of stocks you want to own- take a look at what dividend mutual funds have in their portfolios if you need inspiration- and then take a look which ones are most attractive. Buy those two this month, buy the next three the month after, and so on. If the BOC sets a rate increase, buy your gics after that. You will feel better getting it over sooner than later( at least I would).
Before you buy stocks, you should be prepared for the fact that they are going to move up and down in price- and that you are going to be a buy and hold investor! If you are already planning on losing sleep when your stock portfolio dips down $5k or so then put a higher percentage of gics or bonds in there... :thumbsup:
suzy

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Re: How to invest a lump sum

Post by OnlyMyOpinion » 03 Sep 2017 10:12

longinvest wrote:
02 Sep 2017 18:36
OnlyMyOpinion wrote:
02 Sep 2017 18:13
Still, if it takes the psychology of DCA to get your lump sum invested, then it has merit IMO.
The thing is that the average allocation over the period is 50% in stocks, 50% in cash. Why not invest the money, instead, into a 50/50 portfolio from the start? Why push the client into a higher stock allocation than he is willing to invest into?
...
I was assuming someone who knows they want to invest in the market (equities), and does have the discipline to stay in for the long term, but is just second quessing putting a large lump sum into it all at once. I have faced this several times and had the same anxiety.
I don't think the OP ever made clear exactly what market they plan to invest in, what allocation they intend or what their overall assets look like. All they mentioned was that stock prices seem high right now.
My assumption may be entirely wrong, it may be that the OP needs to be (re)considering the overall asset allocation they are comfortable with.

Added: I see in wisdomseeker's other thread that they intend to follow a CCP approach, assertive, using TD e-series. So I guess we should be suggesting how they get fully invested in that porfolio. (They had no replies to their posting of that thread)
Your caution about determining their actual comfort with a 75% equity (25/25/25) portfolio certainly would apply though.

viewtopic.php?f=29&t=120404&p=600173#p600173
.
Added2: Wisdomseeker. I would say your plan (per the other thread) is fine - use the TD e-series as you propose. Make sure you understand and are committed to staying the course even if (when) they drop in value (as they will).
I would not seek additional emerging market exposure - stick with your portfolio per CCP.
I would invest all funds you have in a lump sum to establish the asset allocation per CCP.
You mention a large sum not be invested for a few years - why is that? I would invest it as above. Otherwise put it in a HISA.

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Re: How to invest a lump sum

Post by ghariton » 03 Sep 2017 15:48

Here is my personal summary of the above. If you are contemplating going swimming in a very cold lake, do you jump in, or do you edge in, inch by inch? If this is causing a real dilemma for you, perhaps you shouldn't go in at all.

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Re: How to invest a lump sum

Post by kcowan » 03 Sep 2017 16:06

I inch in George. Is that like a boiling frog? If someone has a belief that the markets will correct, they should stay on the sidelines. Worst case, they are wrong and lose some opportunity. Would they rather lose opportunity or money?
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Re: How to invest a lump sum

Post by Koogie » 03 Sep 2017 16:31

Man, a lot of you people seem to forget what it is like to be new to investing. It is scary for people to know what to do with their hard earned money and perfectly normal. It doesn't mean they don't belong in the market.

OP, your reading is perfectly correct and the math always says lump sum is better. Of course, we're not ALL emotionless mathematicians... :P
But successful investing for most people is as much about investor psychology as it is about math. As you seem to know, you will be giving up something (return) by DCA. Time in the market vs market timing and all that.

I just try to follow a simple mantra. Done is better than perfect.
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Re: How to invest a lump sum

Post by ghariton » 03 Sep 2017 16:49

Koogie wrote:
03 Sep 2017 16:31
Man, a lot of you people seem to forget what it is like to be new to investing.
My memories of starting to invest are hazy indeed, although I seem to remember stepping right into the bear market of the late 1960s. But I do remember learning to swim, and being ordered into the deep end of the pool at my local YMCA. Scary indeed. But if you want to learn to swim, you have to let go of lifebuoys and other crutches, and actually swim.

I draw an analogy with investing. Put a little or a lot of money into the equity markets, according to your risk tolerance. But once you have made that fundamental decision, just do it. As long as you haven't jumped in, you are not really committed. You might never go in properly. Worse, you might jump out if you get scared (as OMO suggested upthread).

DCA might give you a sense of security, but it is a false sense. You have to face up to the volatility of markets some time. Might as well do it up front and realize what you are getting in to.

That said, I remain a big believer that people should take the route that makes them feel the most comfortable. If DCA is the only way one will get into the market, then so be it.
I just try to follow a simple mantra. Done is better than perfect.
Agree. But ISTM that is the problem with DCA. You're not "done" for a period of months. Plenty of time to get cold feet.

George
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Re: How to invest a lump sum

Post by Quebec » 04 Sep 2017 10:43

longinvest wrote:
02 Sep 2017 12:50
I added a section about behavioural pitfalls. Feel free to improve it, including fixing any incorrect usage of Canadian English (e.g. behaviour vs behavior).
I'll let others write about so-called psychological benefits(???). (I don't believe in them).
I've started a section on psychological benefits, summarizing the discussion above, for the finiki article on DCA. I've also included George's very cold lake analogy. This whole article can still be improved, anyone is welcome to contribute! If you don't want to become a finiki editor, you can use the ''Help improve this page'' link at the bottom of the article, or post comments here. Thanks guys.
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Re: How to invest a lump sum

Post by wisdomseeker » 04 Sep 2017 13:09

Thank you very much for all your interesting response! I also wanted to thank OnlyMyOpinion for posting this link http://www.moneychimp.com/features/dollar_cost.htm . That is exactly what I wanted to see!

Yes, indeed, in a previous post that was written too quickly, I mentioned that I wanted to use TD e series fund and simply follow the couch potato model portfolio http://canadiancouchpotato.com/wp-conte ... s-2016.pdf . This was when I was planning to invest my money over time in smaller increments. While looking at the interest rate I earn, I am not planning to follow that route. I was also planning to take more than one year to invest the money which is not a good idea unless the market crashes. I would love to be able to predict the future and know the date when stocks will go down to make my purchase but I accept the fact that I cannot predict the future (so I will not try to time the market).

However, given that I will be making a larger investment at once, I think that ETFs might be a better option for me (lower MER). These were the recommendations in terms of bonds and stocks (Canadian couch potato) http://canadiancouchpotato.com/wp-conte ... s-2016.pdf . I will need to research this more but I would love to hear any suggestions on this model portfolio for ETFs.

I mentioned that I would be an assertive investor but after thinking about it, it is best for me to be a balanced investor.

However, when investing at times when the market is high, I believe that being more conservative (having more bonds) would make me more comfortable. Then, if the market goes down and stock prices are lower, I would readjust my portfolio by selling some bonds and purchasing more stocks (to have a portfolio with 40% bonds and 60% stocks)

Now here is my new concern (or area where I need to be educated). It concerns the warning from some, including the famous Burton Malkiel (author of Random Walk Down Wall Street) have given.

He recommends against purchasing bonds. Many people assume that bonds are pretty safe (but may not give you a high rate of return). However, Malkiel talks about the fact that "....at the end of World War II. It was the last time rates were about the same place where they are today. Government rates were about the same as they are today. They were pegged until the early 1950s, and then they were allowed to rise only gradually. Bonds were a horrible investment through the whole period of the ‘50s and ‘60s and ‘70s, up until 1980." http://www.morningstar.com/cover/videoc ... ?id=610478 In this video, he makes some recommendations when it comes to replacing bonds. There are a number of videos and articles where Burton Malkiel recommends against bonds. Here is another one: https://www.youtube.com/watch?v=Go2CnKg ... e=youtu.be (in the youtube video, he talks about bonds starting at 5:00)

Bonds is now my concern and the area I need to educate myself before I place a large percentage of bonds in my portfolio (to limit risks!). I would love to hear your thoughts on this topic

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Re: How to invest a lump sum

Post by Koogie » 04 Sep 2017 14:00

Don't forget there are other types of Fixed Income products other than bonds. Nothing says your allocation to FI has to be solely bonds (or bonds at all). GICs and HISAs would fit the bill. Others here would include preferreds and possibly convertible debentures.

I know very little about the latter two except to say that I always thought a convertible debenture was an open topped car driven by someone with no teeth.. :P
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Re: How to invest a lump sum

Post by ghariton » 04 Sep 2017 14:26

As koogie says, there are a lot of forms of fixed income. Indeed, there is a large variety of bonds. Some expose you to credit risk, i.e. the issuer could default on the interest or principal. For this corporate bonds are worse than government bonds. Some bonds expose you to market risk (also known as interest rate risk) -- the market value of a bond varies inversely with interest rates. Long-term bonds react more violently than short term bonds. Some bonds have liquidity risk -- they trade infrequently, so that, if you want to sell (or buy) one, you may get a price quite different from value.

To my mind, the biggest risk associated with bonds (and most other forms of fixed income) is inflation risk, i.e. if the principal is fixed, over time inflation erodes the value that you get at maturity. However, you can get "real return" bonds whose face value is indexed for inflation.

Despite all of these risks, I think that bonds (or fixed income in general) should be part of almost everyone's portfolio. The reason is that the value of a collection of bonds tends to be quite stable, certainly much more stable than a collection of equities, or commodities, or even real estate. So holding bonds makes your total portfolio less volatile. When equity markets drop, your portfolio drops less. This is important because many investors discover that downward volatility is very unpleasant. They may panic and sell at or near the bottom. Repeat this behaviour several times, and you have just defeated yourself.

So holding bonds decreases volatility and helps investors make rational decisions. Yes, in the long run their return will likely be inferior to equities. But if they can help you through the downturns (and there will be downturns), then the lower rate of return is worthwhile, in my view.

What proportion of your portfolio should be in fixed income? The minimum necessary to let you sleep at night when next we have a bear market (a drop in equities of more than 20%). If you are very risk averse, hold enough fixed income for you not to panic if there is a 50% drop in equities. Only you know yourself well enough to make this decision -- and even then, most of us have been surprised at how much risk hurts when it actually happens.

George
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Re: How to invest a lump sum

Post by kcowan » 05 Sep 2017 09:58

The think the market for bond makes them less of an alternative to stocks. If all my bond are marked to market and liquid, they look pretty much like equity but with less leverage. It is true that they are less liquid and that can be a good thing. Partly it is because of their less leverage.

The Schedule 3 required to claim bond losses is not even a standard form. And it is poorly understood by the investment community in general.
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