Dollar Cost Averaging is a Myth?

[JAC]

I used to believe that constant, regular purchases of a security minimizes market risk. However, now I read that this is wrong, either as compared to the same number of buys at random intervals, or even lump sum investing.
One site says, "Here's the problem: It's bunk. Finance professors have known this for more than 20 years, since an article disparaging the concept appeared in the Journal of Financial & Quantitative Analysis in 1979. Since then, numerous studies have confirmed this analysis. And yet, "despite more than two decades of damning evidence, DCA remains as popular as ever amongst the rank and file of individual investors," wrote Moshe Arye Milevsky of the York University (Ontario, Canada) school of business in a journal article in 2001." (http://moneycentral.msn.com/content/P104966.asp)
Another says "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." (http://www.moneychimp.com/features/dollar_cost.htm)
I can see why random buys would perform similarly. One argument in favor of lump sum buying is said to be that markets go up about twice as often as they go down.
TSPers don't have a lot of choice, obviously, but I think it is interesting that such a widespread belief is said to be wrong (in the sense that DCA is not superior to other methods). What does anyone else think?
Jonathan

 

[rokid]

Do know the title/author of the 1979 article referenced by Mr. Middleton?

I have read articles comparing the advantages of investing a lump sum to DCA when you have a lump sum to invest. For example, if someone leaves you $1M. However, DCA investing over a long period of time into a 401K seems to be universally applauded.

 

[JAC]

Nope. Online indices only back to 1995. DCA is reasonable given computerized banking. It makes people invest regularly. Sales people like it because they get your $$ in a perpetual stream.

BUT, the reason usually given is that that it reduces market risk or the average longterm cost of the security better than lump sum or stochastic investing, which seems to be false. When you think about it, random would be just as good, and to beat the longterm average cost of the security (no matter when you invested), you'd have to time the market to avoid highs, and that requires prediction, which is exactly what DCA was supposed to finesse.

 

[rokid]

Nope. Online indices only back to 1995.

I'm not quite sure I understand your statement. I have TSP fund index data back to 1988. I have C Fund, I Fund, and REIT data back to 1970 (S&P 500/EAFE/NAREIT indexes). Most researchers use stock/bond market data starting in 1926.

I find Mr. Middleton's referencing of a study - no author, no title, suspect. In addition, it's easy to come up with scenarios in which DCA would out perform lump sum. For example, this year, lump summing the I Fund on 9 May would have been a disaster compared to starting a DCA program on the same date.

Mr. Middleton may very well be right. However, it's hard to verify his claim without reading the referenced study.

 

[JAC]

Sorry, I meant the online indices to the Journal of Financial & Quantitative Analysis only go back to 1995, so unless someone has access to that pub, we'll probably never know what the academic said.
Looking back in time one can certainly pick days when lump summing does better or worse than DCA. The hard part is looking forward. That's also why one of the articles said stocks move up about twice as often as they move down. If true, I guess it means bull markets last longer than bears. That might mean that lump sums are better than DCA because you get all your money into the rising market ASAP, as opposed to stretching it out. In a falling market, DCA would outperform single large buys.
DCA assumes that you can't time the market...in the long run, it's equivalent to many small random buys. If you can time the market, then lump sum might be better, unless missing out on lots of little bounces did you in.
I think the point is that DCA is no better that other ways. It's neutral.
J

 

[JAC]

And, what we do here is pretty much lump sum transfers, no? For example, did the market last week find a new bottom, or was it part of the much anticipated 10% correction? If the former, transfer a big amount to the C fund. If the latter, DCA into the C fund. But few here DCA in and out of funds, tho I guess we all DCA into TSP to maximize employer matches, etc.
My point. If DCA'ing was a sure bet, then I ought to move that 30% into the C fund in 15 weekly trades of 2%, not 30% tomorrow.
J

 

[rokid]

If DCA'ing was a sure bet, then I ought to move that 30% into the C fund in 15 weekly trades of 2%, not 30% tomorrow.
J

Nothing is a sure bet. However, if to DCA or not is important to you, I'd get a copy of the study. Alternatively, engage Birchtree in a conversation. He's a huge DCA advocate.

 

[JAC]

I'm not personally committed one way or the other. Just back into learning about all this stuff after a gap and while nosing around found these attacks on DCA, which made sense. This being the longterm strategy forum, thought I would see if anyone had an opinion. I suppose Birchtree will happen upon this if he's interested.

 

[Birchtree]

JAC,

Your investing strategy may depend on the amout of energy you have available to stay market current. When a member asks me for a recommendation prior to deployment for example, I usually tell them to put their DCA on automatic pilot, suggesting 75% C fund and 25% I fund until they are in more control. Fate can be an excellent guide providing you have a trust in fate. It's a simple way to cycle ride and accumulate as many shares as possible with the least amount of energy expenditure. I would rather accumulate the shares than push for the dollars - the dollars will eventually arrive on their own accord. I want 40,000 shares backing me up when I'm ready to pistol shoot - and staying with TSPtalk will help educate me in the fine art of hitting the targets. When you play with that kind of money you don't want to make many mistakes. There will be more volatility going forward in the next few years and I'll be ready with my dual Sturm Rugers.

Dennis

 

[Dave M]

Shares vs Dollars

This is the question I can't answer, consistently. I once believed that number of shares was the key. Then I thought, the only reason to accumulate shares is in order to accumulate dollars, so why not count dollars instead?

Which would you rather have, lots of shares worth nothing or lots of dollars worth nothing?

Dave

 

[Birchtree]

I'll take the shares every time - because once they are yours they are yours. They may fluctuate in value over the years as you accumulate them, but they still remain yours. And at some point in the distant future the gift horse may come along at the right time - and bingo you do an IFT for safety. Wasn't that easy?

 

[GordonGecko]

Why look at DCA as an 'all-or-none' proposition? Why not use a combination of DCA and technical analysis to adjust the contribution rate?

Since markets, when viewed from a long-term perspective, have discernable trends, for example an intermediate trading-range within the long-term uptrend, adjustments in contribution allocation can be used to take advantage of those fluctuations.

It's not that hard to identify the upper and lower trading range, and adjust your contribution allocation accordingly, depending where the index value is within the trading range.

For example, in a 'long-term up' market, you calculate the 50-week or 60-week moving avg of the S&P 500 (this is assuming that the index value is higher than the MA), then adjust your contribution allocation upward as the index falls closer to the average, and decrease it as it moves up and away. You still maintain DCA throughout, but at a varying rate.

The same goes for declining markets. If the MA is declining and the index value is below the MA, then you decrease the contribution allocation the closer you get to the MA, and increase it as it moves farther away.

This is clearly an improvement over using DCA with a constant rate of allocation.

In summary, contribution adjustments ought to take into account that intermediate changes in price within the long-term trend can be measured, and should increase the number of shares over the 'constant rate' approach.

 

[nnuut]

EXACTLY GG!!!

 

[JAC]

GordonGekko's point assumes you can time the market successfully, whereas the usual rationale for DCA is exactly the opposite: it minimizes risk regardless of market-timing. But that turns out to be a myth. Of course, this whole site is dedicated to the notion that market-timing works, so one wouldn't expect subscribers to think otherwise.
There are psychological and efficiency reasons to DCA: think hard, make your choice, and set it on auto-pilot.
But the original query had to do with whether regular small buys reduced the long-term average price of the security compared to random buys or even lump-sum. Apparently it does not.

 

[GordonGecko]

Agreed. My slightly off-topic point was that both DCA and market timing approaches each have benefits. Why not use the best from each?

My opinion is that a combined approach is more likely to be more successful than either DCA or market timing alone over the long haul. Do I have proof? No.

I can say it takes into account that few can make accurate predictions about short-term market direction, while intermediate and long-term market direction are not difficult to determine.

 

[Pilgrim]

Try this one - conclusion: It's Bunk

"The costly myth of dollar-cost averaging"
http://moneycentral.msn.com/content/P104966.asp

 

[charmedboi82]

Try this one - conclusion: It's Bunk

"The costly myth of dollar-cost averaging"
http://moneycentral.msn.com/content/P104966.asp

The conclusion I've reached from all of this is that it really depends on what happens in the future. They're using the logic that markets rise twice as often as they fall, so they're using the past to 'predict' the future. Of course, you could set the example up to show a market drop. So, of course, it depends on what you're investing in and what happens in the future. The future's always up in the air.

Also, they're talking about dollar-cost averaging, but as in the article, contributing to a 401/TSP/IRA every pay period is NOT dollar-cost averaging. It states this clearly. It's the difference between having the lump sum to invest initially and not having it (spacing it out over time because you have to, not because you have a choice).

 

[VirginiaBob]

Of course, investing with a large lump sum is better, but if you had a large lump sum to begin with, it's likely to be family money, which most of us didn't have access to.

 

[Partyartie]

Having read the Middleton article and digested all that has been written here, I find that I cannot/will not write off the concept of dollar cost averaging. Since the statistics show that investing in common stocks has provided the best return (compared to other types of investments) since the 1920's, it isn't hard to understand that investing in a lump sum would provide a larger return, particularly over a long period of time.

I feel it is important to recognize, however, that investing equal sums on a periodic basis should (at least theoretically) address short-term ups and downs in the market, and in some manner address the small investors qualms about "losing money".

If the DCA concept was indeed conceived to extract the funds from small investors that they were unwilling or unable to commit in a lump sum, I still feel it's indeed better that they invest on a DCA basis, rather than not invest at all. If it does address those short-term peaks and valleys, then so much the better.

Certainly, you true financial aficionados can speak derisively of such a basic (or possibly even wrong-headed) concept, but it may have some value for those who are not financially astute, or are just beginning to invest.

 

[Birchtree]

I'm a seasoned investor and DCA is my redeemer. I enjoy looking back over dividends and allocations that have been previously reinvested and noticing the low prices. I wish I could be so smart on my timing.