Here is a real life example of what I have been saying. Between 1997 and 2003 intermediate term treasuries returned 7.57% and had a standard deviation of 6.4%, the definition of a good investment. Over the same period emerging markets returned 1.76% and had a standard deviation of 37.06% (the definition of a bad investment), as seen at Portfolio Visualizer.
https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&portfolio3=Custom&portfolio2=Custom&portfolio1=Custom&annualOperation=0&initialAmount=1000&EmergingMarket1=100&FiveYearTBills2=100&endYear=2003&mode=2&inflationAdjusted=true&annualAdjustment=1000&startYear=1997&rebalanceType=1&annualPercentage=0.0.
Someone who began with $1,000 in intermediate term treasuries ended this period with $1,666, while someone who began with $1,000 in EM ended with $1,130. This is a resounding example of volatility and emerging markets being bad investments, right?
Wrong.
If the same two people began with $1,000 and then invested an additional $1,000 per year, the person investing in intermediate term treasuries ended with $11,181, while the person investing in emerging markets ended the same period with $11,456. Furthermore the EM investor accumulated so many shares during this period that their investment subsequently soared.
https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&portfolio3=Custom&portfolio2=Custom&portfolio1=Custom&annualOperation=1&initialAmount=1000&EmergingMarket1=100&FiveYearTBills2=100&endYear=2003&mode=2&inflationAdjusted=true&annualAdjustment=1000&startYear=1997&rebalanceType=1&annualPercentage=0.0That is right.
The person buying into an asset with a return of 1.76% and a standard deviation of 37.06% actually ended with more money than the person investing in an asset with a 7.57% return and a standard deviation of 6.4%. The primary factor behind this outperformance was dollar cost averaging into a highly volatile period. Mathematically, volatility
will benefit a dollar cost averager, and more volatility will be of more benefit. However there will be many other things at play and volatility may or may not be the dominant factor over any given time frame.
Now for some cautions, exceptions, etc. First, it is implicit that volatility would be correspondingly bad for a person regularly selling a fixed dollar amount. Second, at some point the impact of volatility on accumulated wealth will become greater than its benefit to new contributions, and it is possible it will result in a loss that is not recoverable over a reasonable time frame. For these two reasons it would be very important to begin a glide path into less risky assets almost immediately (for example by increasing target bond allocation by 2% or 3% annually until the final desired portfolio is reached). Third, over the long term compound returns will always come to dominate. Fourth, there are many potential pitfalls with buying highly volatile assets, for example the investor might panic and sell low, or might lose employment and be forced to make highly detrimental withdrawals. For these reasons I am not advising to go all-in with this, I am just pointing out that it may be possible for some people to use this mechanism to their advantage.