Author Topic: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest  (Read 7938 times)

arebelspy

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Lifehacker posted a great article today: The Pros and Cons of Using Dollar Cost Averaging to Invest

It includes multiple links to research on the topic.

For those that just want the straight math:
Quote
On average, we find that an LSI approach has outperformed a DCA approach approximately two-thirds of the time, even when results are adjusted for the higher volatility of a stock/bond portfolio versus cash investments...since the average returns of stocks and bonds exceeded that of cash over the full span in each market. These positive returns are responsible for the relative success of LSI over DCA. This is really quite intuitive—if markets are going up, it's better to put your money to work right away to take full advantage of the market growth. We found that any factors unrelated to market trends had a minimal impact on the results.

The whole thing is worth a read if you're not sure if DCA or lump sum is right for you.
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aclarridge

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #1 on: September 04, 2014, 03:05:26 PM »
I think this topic can be summed up concisely as:
                                                    DCA    LSI
Expected returns:                        lower  higher
Std Deviation of returns (risk):     lower  higher

I checked (somewhere in my post history) the sharpe ratio (measure of risk adjusted return) using data for a study on DCA vs. LSI and found DCA to be better using that metric. It's prudent for folks in certain situations, like those just starting to invest a large proportion of their target retirement net worth.

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #2 on: September 05, 2014, 06:31:46 AM »
Since all sectors of the stock market do not move in tandem, another wrinkle here could be to LSI in the sectors moving up, and DCA into the sectors moving down.  Adjust sectors as needed.

arebelspy

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #3 on: September 05, 2014, 07:44:36 AM »
Since all sectors of the stock market do not move in tandem, another wrinkle here could be to LSI in the sectors moving up, and DCA into the sectors moving down.  Adjust sectors as needed.

Uh huh.

And where do I get the crystal ball that tells me which will move up and which will move down?
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solon

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #4 on: September 05, 2014, 07:48:54 AM »
This is definitely market-timing, and the opposite of dollar-cost averaging.

dandarc

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #5 on: September 05, 2014, 07:52:36 AM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Panly

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #6 on: September 05, 2014, 08:20:14 AM »
Since all sectors of the stock market do not move in tandem, another wrinkle here could be to LSI in the sectors moving up, and DCA into the sectors moving down.  Adjust sectors as needed.

Uh huh.

And where do I get the crystal ball that tells me which will move up and which will move down?

that's not what the quote  implies.

imho it just suggest that you direct new funds towards those assets that became cheaper, relative to the rest of the portfolio.

Uh huh.



solon

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #7 on: September 05, 2014, 08:23:24 AM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yeah, that's true. DCA is really only for money you don't have yet, like deductions from paychecks. If you could take the next ten years' worth of salary deductions and invest them right now, that would obviously be better that DCAing over the next ten years. But since we don't have that option, we DCA.

dandarc

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #8 on: September 05, 2014, 08:39:10 AM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yeah, that's true. DCA is really only for money you don't have yet, like deductions from paychecks. If you could take the next ten years' worth of salary deductions and invest them right now, that would obviously be better that DCAing over the next ten years. But since we don't have that option, we DCA.
Right - but if you don't have the money yet, there really isn't much of a decision to make - obviously I can't invest money I don't have in hand.  Usually in academic articles on the topic, regular investing <> DCA.  Having the money withheld from your paycheck is more like LSI than DCA - you're pretty much investing as soon as you get the money, assuming you do what most people do, and just declare what funds you want in the 401K.  It looks a lot like DCA, but as you point out, you don't actually have the money yet, and the absence of being able to decide is critical to the analysis of which option is better.

To actually DCA you'd have to have the money put into a money-market fund, then periodically move a portion into stocks / bonds.  Say you were paid monthly - you might put it all into MMA initially, then weekly move a portion of that into your stock funds.  Not what most people do with 401Ks.

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #9 on: September 05, 2014, 09:40:06 AM »
Since all sectors of the stock market do not move in tandem, another wrinkle here could be to LSI in the sectors moving up, and DCA into the sectors moving down.  Adjust sectors as needed.

Uh huh.

And where do I get the crystal ball that tells me which will move up and which will move down?

that's not what the quote  implies.

imho it just suggest that you direct new funds towards those assets that became cheaper, relative to the rest of the portfolio.

Uh huh.





This exactly!

dandarc

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #10 on: September 05, 2014, 10:00:23 AM »
Lots of concepts in this thread:

1.  Orignally, Lump-sum Investing vs Dollar Cost Averaging - LSI = I've got X amount to invest, I'm going to invest it all today.  DCA = I've got X amount to invest, I'm going to invest X/12 per month for a year (as an example - you could DCA daily, weekly, annually)
2.  Market-Timing - if you make a decision based on which sectors "are going up vs are going down", you are trying to time the market - we can know which sectors "have gone up vs have gone down", but not if that trend will continue, for how long, etc.
3.  Rebalancing - specifically rebalancing when purchasing more shares - some have interpreted RTW's comment as this, but when taken literally it is market-timing
4.  Regular, systematic investing - things like 401K deductions from payroll - often looks a lot like DCA, but is not exactly the same thing.

Does this forum have a go-to glossary?  Sometimes it seems we have different ideas of what the various terms mean, which can hinder discussion.

Heart of Tin

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #11 on: September 05, 2014, 10:05:33 AM »
Since all sectors of the stock market do not move in tandem, another wrinkle here could be to LSI in the sectors moving up, and DCA into the sectors moving down.  Adjust sectors as needed.

Uh huh.

And where do I get the crystal ball that tells me which will move up and which will move down?

that's not what the quote  implies.

imho it just suggest that you direct new funds towards those assets that became cheaper, relative to the rest of the portfolio.

Uh huh.

However, if we define relatively cheaper as "grew at a slower rate since I last invested", then we would constantly be pushing money into the slower growing asset. Sometimes that will work out and sometimes it won't.

A meaningful definition of which assets are relatively cheaper would take into account how much growth we expect between when we buy the assets and when we sell them, and that would, indeed, require a crystal ball.

Kaspian

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #12 on: September 05, 2014, 12:42:58 PM »
DCA may not be statistically better way to go, but I believe it's the *best* way to go for most people for two main reasons:

1.  Because in DCA the money just comes out after you get your paycheque.  You're stashing it immediately and then don't have to think/account for it.
2.  If the idea of lump-sum investing prevails among people giving advice then the average person will attempt to build up a lump-sum fund before investing.  ...And we know that most people aren't very good at saving up at all.  Their money will also have to sit in a low-interest holding area getting dusty (instead of making returns) while they wait for what they believe to be an ideal lump-sum number.

But if you stumble upon/inherit/sell property and get a huge chunk in one fell swoop, I'd certainly tell people to lump-sum it in. 

arebelspy

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #13 on: September 05, 2014, 05:31:26 PM »
Since all sectors of the stock market do not move in tandem, another wrinkle here could be to LSI in the sectors moving up, and DCA into the sectors moving down.  Adjust sectors as needed.

Uh huh.

And where do I get the crystal ball that tells me which will move up and which will move down?

that's not what the quote  implies.

imho it just suggest that you direct new funds towards those assets that became cheaper, relative to the rest of the portfolio.

That's how I read it.

But even under your explanation, I still see no reason to invest that way without making a prediction on the future.  Is there some expectation for those cheaper ones to the outperform?  Maybe there's a reason why they're cheaper now.

Maybe though I should start pushing all my extra funds to WCOM.

I also get the feeling, reading the responses, no one actually read the article, just rushed to post their opinions on investing.  Hopefully it will help some diligent investor though.  :)
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ender

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #14 on: September 06, 2014, 07:49:36 AM »
Quote
Let's say you've saved some money, and you're ready to invest it for your retirement. Maybe you plan to buy some index funds. You might be scared of investing everything at once—what if your shares plummet the next day?

...

For some people, DCA is less an investment strategy and more a necessity. Most of us don't have a huge lump sum to invest at once, so we save small chunks from our paychecks.

This is basically why I do LSI now.

I am saving money for a house right now, in cash, and so every spring I have the ability to "borrow" from that savings, so I am able to max out my IRA/401k/HSA at the beginning of the year and then refill the savings at the end of the year.

One thing I dislike is the 67% vs 33% figure in the article. If LSI averages a 1% overall improvement but DCA is an average of 10% better then even though DCA is more frequently worse, it would still have a better expected return.

Fortunately, this article has statistics on this:
Quote
Investing all at once was the better strategy in 552 of 781 possible periods -- more than 70 percent of the time. In addition, in the roughly 30 percent of the instances in which DCA outperformed, the magnitude of that outperformance was less than when following lump-sum investing. Specifically:
  • When lump-sum investing outperformed, the average outperformance was $940,301 on the initial $1 million investment.
  • During the 229 periods in which DCA did better, the average cumulative outperformance was $769,311.


arebelspy

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #15 on: September 06, 2014, 09:30:24 AM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yup.  I love this viewpoint of it.  (Aside from the simplification of tax stuff, but if you aren't selling everything in your 401k/Roth/etc. and then DCAing it in, you are choosing to lump sum every day.)

Well said.
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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #16 on: September 06, 2014, 11:15:56 AM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yup.  I love this viewpoint of it.  (Aside from the simplification of tax stuff, but if you aren't selling everything in your 401k/Roth/etc. and then DCAing it in, you are choosing to lump sum every day.)

Well said.

This is a simplification of it all that ignores any risk component. Sure, LSI might be better than DCA most of the time, but what happens when it is worse? How much worse can it be, etc.?

Heart of Tin

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #17 on: September 06, 2014, 12:06:42 PM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yup.  I love this viewpoint of it.  (Aside from the simplification of tax stuff, but if you aren't selling everything in your 401k/Roth/etc. and then DCAing it in, you are choosing to lump sum every day.)

Well said.

This is a simplification of it all that ignores any risk component. Sure, LSI might be better than DCA most of the time, but what happens when it is worse? How much worse can it be, etc.?

For a slightly more in depth look at the risk, see the Vanguard article that arebelspy's article cites (pdf warning): https://pressroom.vanguard.com/content/nonindexed/7.23.2012_Dollar-cost_Averaging.pdf

Figure 3 is the most informative. I'll transcribe the American data below.

The figures represent a ranking of LSI balances subtracted from DCA balances. The LSI balance is defined as the end value of $1,000,000 fully invested for ten years. The DCA balance is defined as the end value of twelve equal investments totaling $1,000,000 invested monthly for one year and fully invested for nine years.

United States 1926 - 2011
5th percentile  -$203,776
25th percentile  -$ 42,819
50th percentile  $ 55,151
75th percentile  $151,725
95th percentile  $309,133

arebelspy

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #18 on: September 06, 2014, 01:03:09 PM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yup.  I love this viewpoint of it.  (Aside from the simplification of tax stuff, but if you aren't selling everything in your 401k/Roth/etc. and then DCAing it in, you are choosing to lump sum every day.)

Well said.

This is a simplification of it all that ignores any risk component. Sure, LSI might be better than DCA most of the time, but what happens when it is worse? How much worse can it be, etc.?

I think you're missing the point of the hypothetical.

If you think LSI is worse, then you should sell your whole portfolio, and DCA it in over the next 12 months.  Then when it's fully invested, sell it all and DCA in again.

By not doing that, you're basically choosing the option of "sell it all, and lump it all in" (by not selling, which is equivalent, minus tax issues/wash sale issues/etc.).

If your argument, in this post, is that LSI has risks, yes, I agree.  And you're choosing to embrace those risks when you aren't selling off your portfolio and DCAing it back in, every day you're choosing that.
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aclarridge

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #19 on: September 09, 2014, 03:45:55 PM »
My thought for the day -

Aren't we all deciding to lump-sum invest every single day with our existing balances?  You could, at any time, sell it all and move to cash (or bonds or whatever), then DCA back in on whatever schedule you like.  How is that any different than the classic scenario where you get a windfall, or saved up the money and have just decided to invest it?

Yup.  I love this viewpoint of it.  (Aside from the simplification of tax stuff, but if you aren't selling everything in your 401k/Roth/etc. and then DCAing it in, you are choosing to lump sum every day.)

Well said.

This is a simplification of it all that ignores any risk component. Sure, LSI might be better than DCA most of the time, but what happens when it is worse? How much worse can it be, etc.?

I think you're missing the point of the hypothetical.

If you think LSI is worse, then you should sell your whole portfolio, and DCA it in over the next 12 months.  Then when it's fully invested, sell it all and DCA in again.

By not doing that, you're basically choosing the option of "sell it all, and lump it all in" (by not selling, which is equivalent, minus tax issues/wash sale issues/etc.).

If your argument, in this post, is that LSI has risks, yes, I agree.  And you're choosing to embrace those risks when you aren't selling off your portfolio and DCAing it back in, every day you're choosing that.

Ok, I spent about an hour on this post, rewrote a bunch of times. Have to think about this stuff carefully.

All us long-term investors are making the LSI choice every day - I agree with that.
DCA simply allows somebody to "ease in" to their desired asset allocation in a risk-averse way. Should their asset allocation be more risk-averse to begin with, then, and use LSI with that allocation? Yeah maybe. Both seem like reasonable strategies to me from a risk-adjusted return perspective.

As to the scenario where somebody gets a windfall, and why wouldn't the advice to DCA (or something similar) apply to somebody who's already invested, I don't think there's a contradiction there at all - the way I see it the person who's already invested should be at the level that they're recommending to the other person already because they just got there gradually.

As I accumulate assets, my asset allocation will become less risky - it's a gradual change. Think of the conventional wisdom of "your age in bonds" but just instead of age, use "% of the way to your FI number" as a measure of progress toward your desired FI asset allocation (less risky than your current one, right?). A windfall is a step jump in assets, so the allocation/portfolio should become safer in a step jump as well. How that gets implemented could be DCA or a change in the bond portion of the portfolio or a combination of the two.

Of course we shouldn't all go through DCA cycles all the time, but I think we can recognize it as an acceptable strategy for reducing risk at the expense of higher returns in "windfall" type scenarios.

arebelspy

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Re: Article: The Pros and Cons of Using Dollar Cost Averaging to Invest
« Reply #20 on: September 09, 2014, 04:16:50 PM »
I agree.

Ultimately one has to do whatever will help them sleep at night (hopefully with full knowledge of what they're doing, and the consequences of the decision, and the alternative decisions).  :)
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