Author Topic: How to do dollar cost averaging with a small budget  (Read 5033 times)

cerberusss

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How to do dollar cost averaging with a small budget
« on: July 09, 2013, 12:33:47 AM »
European here. I'd like to put away some money, so that when my daughter goes to college in ~18 years time, there's a bit of money.

To that end, I thought about putting 2,000 euros in a Vanguard fund. I don't really need more -- college is cheap here and I expect her to have a student job on the side. The end result of the 2K will get her through the first year of college and for the remaining years, I'll educate her enough to figure out the remaining finances herself.


However by just moving 2K from my savings account into a Vanguard fund, I am essentially timing the market, right? Is that wise?

Alternatively, if I move a 100 per month into the Vanguard fund and keep that up for 20 months, I am dollar cost averaging. But again, that's over a relatively short period and thus I was wondering if I'm again timing the market?

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Re: How to do dollar cost averaging with a small budget
« Reply #1 on: July 09, 2013, 01:49:19 AM »
I'm not too sure how investing for 18 years is timing the market, seems pretty long time to me.

Is vanguard available in europe? It's a good idea to invest it for her, even if she doesn't need it for college, it would be good "moving" out money it she wanted, or some other things.

The 2k amount, I got nothing to say on this... I'm american and have no idea what costs are like over in europe.

matchewed

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Re: How to do dollar cost averaging with a small budget
« Reply #2 on: July 09, 2013, 04:22:43 AM »
It's more like lump sum investing. If you were holding onto that cash waiting for a dip it would be timing. If you invest now (which you should) it's just lump sum.

martynthewolf

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Re: How to do dollar cost averaging with a small budget
« Reply #3 on: July 10, 2013, 01:52:41 AM »
Also I'm under the impression that lump sum investing is actually more beneficial than DCA if the sum to invest is available all at once.

(I may be wrong here, if I am someone will come along and explain why) :)

matchewed

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Re: How to do dollar cost averaging with a small budget
« Reply #4 on: July 10, 2013, 04:23:35 AM »
Nope you're right. It's the idea that 10k invested now will have the benefit of those lifetime returns. 10k spread out over X number of time intervals may have a slightly reduced return for each purchase. Present money is best to be lump sum invested. Future money is best to be DCA'd (which is just essentially lump sum investing as the money is invested when it happens to be available).

cerberusss

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Re: How to do dollar cost averaging with a small budget
« Reply #5 on: July 10, 2013, 07:16:03 AM »
Is there some math behind this? I.e. why would present money best be lump sum invested?

aclarridge

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Re: How to do dollar cost averaging with a small budget
« Reply #6 on: July 10, 2013, 07:32:17 AM »
Is there some math behind this? I.e. why would present money best be lump sum invested?

The theory is that the market fluctuates randomly but has an overall trend upwards, in excess of the return available on cash. Therefore if you invest every dollar as soon as it comes available to you, you're maximizing the time each dollar of your money spends in the market. So you would expect the highest return by doing this.

Expected highest return. Sounds good, but there are a plethora of possible outcomes.

Sometimes, people prefer to DCA in instead of lump-sum investing, thinking that sure, I am spending more time in cash, but I'm averaging the cost of getting into the market out over a period of time. So the range of possible outcomes should be a bit narrower than the range of possible outcomes when lump sum investing. So lower risk, and lower expected return.

I'd say you're better off lump-sum investing with such a small amount. If there are any transaction fees then of course that favours lump-sum investing.

matchewed

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Re: How to do dollar cost averaging with a small budget
« Reply #7 on: July 10, 2013, 07:59:05 AM »
Is there some math behind this? I.e. why would present money best be lump sum invested?

10k to invest @ 4% annual.

Initial Investment    $10,000.00     $1,000.00
Month 1    $10,033.33     $2,003.33
Month 2    $10,066.78     $3,010.01
Month 3    $10,100.33     $4,020.04
Month 4    $10,134.00     $5,033.44
Month 5    $10,167.78     $6,050.22
Month 6    $10,201.67     $7,070.39
Month 7    $10,235.68     $8,093.96
Month 8    $10,269.80     $9,120.94
Month 9    $10,304.03     $10,151.34
Month 10    $10,338.38     $10,185.18

*edit* Obvious disclaimer for overly simplistic demonstration.
« Last Edit: July 10, 2013, 08:03:35 AM by matchewed »

Spork

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Re: How to do dollar cost averaging with a small budget
« Reply #8 on: July 10, 2013, 08:04:54 AM »
Is there some math behind this? I.e. why would present money best be lump sum invested?

10k to invest @ 4% annual.

Initial Investment    $10,000.00     $1,000.00
Month 1    $10,033.33     $2,003.33
Month 2    $10,066.78     $3,010.01
Month 3    $10,100.33     $4,020.04
Month 4    $10,134.00     $5,033.44
Month 5    $10,167.78     $6,050.22
Month 6    $10,201.67     $7,070.39
Month 7    $10,235.68     $8,093.96
Month 8    $10,269.80     $9,120.94
Month 9    $10,304.03     $10,151.34
Month 10    $10,338.38     $10,185.18

I'm not arguing here that DCA trumps lump sum...  but I think your math is a bit simplistic.  The whole theory of DCA is tied to fluctuation.  Plopping a static interest rate in there doesn't make much sense.

matchewed

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Re: How to do dollar cost averaging with a small budget
« Reply #9 on: July 10, 2013, 08:13:27 AM »
Hence my edit for disclaimer on overly simplistic example. ;)

It's meant to demonstrate the point not to mimic real life.

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Re: How to do dollar cost averaging with a small budget
« Reply #10 on: July 10, 2013, 08:46:38 AM »
Is there some math behind this? I.e. why would present money best be lump sum invested?

Here is a link to a study showing that a significant portion of the time, lump sum investing beats dollar cost averaging that same lump sum over time.

Of course, if you don't HAVE a lump sum to invest, dollar cost averaging at least keeps you putting into the market!

aclarridge

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Re: How to do dollar cost averaging with a small budget
« Reply #11 on: July 10, 2013, 11:33:44 AM »
Here is a link to a study

This study illustrates what I was saying. Check out Table 2, mean return vs. standard deviation. As expected, lump-sum has a higher standard deviation of possible outcomes, along with a higher expected return.

Anyway based on their results one could compute the Sharpe ratio to try to come up with a "risk adjusted" measure of the returns. I'll do it here because I'm curious. I'll assume risk free in this case is a savings account earning 1%.


1926-91   Mean Return   Std Dev   Sharpe
Lump   0.1275   0.2281   0.515124945
12-month   0.085   0.1321   0.567751703
6-month   0.0997   0.1681   0.533610946
3-month   0.1114   0.194   0.522680412

1950-91   Mean Return   Std Dev   Sharpe
Lump   0.1337   0.1639   0.754728493
12-month   0.0963   0.0983   0.87792472
6-month   0.1097   0.1291   0.772269558
3-month   0.12   0.1461   0.752908966

1970-91   Mean Return   Std Dev   Sharpe
Lump   0.1328   0.1684   0.729216152
12-month   0.108   0.1056   0.928030303
6-month   0.1184   0.138   0.785507246
3-month   0.1251   0.154   0.747402597

So by that metric, with this data, 12 month averaging wins. Still, it's probably prudent to take the "risk" in light of any nonzero transaction fees.

cerberusss

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Re: How to do dollar cost averaging with a small budget
« Reply #12 on: July 11, 2013, 02:02:28 AM »
Okay, from what I'm getting -- yeah to DCA means a tradeoff; slightly lower risk and slightly less performance. However 1K is such a small sum that it doesn't seem to matter much anyway.

cerberusss

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Re: How to do dollar cost averaging with a small budget
« Reply #13 on: July 16, 2013, 02:05:26 AM »
OK threw a cool 1,000 into the Vanguard Global Stock Index Fund, and added a 100 monthly recurring transfer into it as well.

aclarridge

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Re: How to do dollar cost averaging with a small budget
« Reply #14 on: July 16, 2013, 07:07:27 AM »
Nice work. Now, just gotta ignore it for 20 years or so!