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Dollar Cost Averaging: Does it Work?

By JLP | July 27, 2006

John Waggoner of USA Today wrote a column recently titled Dollar Cost Averaging’s Not All It’s Cracked up to be. Here’s the main point of what Waggoner had to say:

“If you invest the same amount at regular periods, you’re using a technique called dollar-cost averaging. The advantage is this: You automatically buy more shares when the market is low and fewer shares when it’s high. For example, if you invest $1,000 in a stock fund at $34 a share, you get 29.4 shares. If the price falls to $27 a share, your $1,000 will now buy 37 shares.

All well and good. But dollar-cost averaging isn’t the panacea it’s made out to be. For example, if you had invested $100 a month in the Vanguard 500 Index fund for the past decade, you’d have had $15,437 in your account at the end of June, according to Lipper.

You’d have invested $12,000 in the fund, so your total profit would be $3,761, or 31.3%. Any gain is good, but 31.3% is a far smaller gain than 122% — the S&P index’s return in the past decade.”

My response: SO WHAT! The problem I have with articles like this is that they address problems that most people have no control over. I mean, what’s the average investor to do? It’s not like the average person can invest a lump sum. Most people have to meet their financial goals by saving a small amount on a consistent basis either through an IRA or 401(k) plan.

Topics: 401(k), Investing, IRAs, Retirement Planning | 9 Comments »


9 Responses to “Dollar Cost Averaging: Does it Work?”

  1. Vlad Says:
    July 27th, 2006 at 12:41 pm

    Great point, JLP. Whining and moaning like this makes me tired.

  2. Ricemutt Says:
    July 27th, 2006 at 1:45 pm

    The problem with all of these studies is they always look back at theoretical investments and returns. At the moment of making the actual decision on whether or not to invest — the only reality that matters — the future outcome is certainly never so plain and clear.

  3. nick Says:
    July 27th, 2006 at 3:22 pm

    The analysis is flawed.

    It is comparing dollar cost averaging of $100/month over 10 years against a lumpsum investment of $12000 at the beginning of the decade.

    As JLP pointed out, these are two totally different games.

    To make fair comparision, we need to discount the monthly investment made over the ten years to the beginning of the decade. That value is the real cost basis of the total investment, which will be significantly less than $12000. Therefore, the 31.3% profit ratio is wrong. It is way lower than the real profit ratio over these ten years.

  4. nick Says:
    July 27th, 2006 at 3:55 pm

    When I think more about it …

    1. %122 profit in 10 years is not that great. It is 8% return every year.

    2. you can not compare the return of a Vanguard fund with the index, they are not the same thing. Due to investment costs, the performance of a broad index fund can never theoretically match the index it is trying to keep track of.

    3. A fair comparision is to assume the dollar-cost-averager has also $12000 to invest at the beginning of the decade. She invested $100 every month into the S&P fund, and at the same time keep those amount yet to be invested in a safe and highly liquid investment vehicle, like a money market fund.

    Granted, if the money market fund returns lower than 8% on average, she won’t be able to beat the index, but still, the performance gap won’t be that wide. More importantly, she gets higher liquidity of her asset over these ten years. Isn’t that worth anything?

    I don’t believe it is on USA Today.

  5. Brian Says:
    July 27th, 2006 at 4:09 pm

    After reading the article it appears the intended targeted audience is those with a lump sum to invest. I don’t understand why is this so upsetting.

  6. fivecentnickel.com Says:
    July 29th, 2006 at 8:16 pm

    Weekly Roundup – 07/28/06

    Here’s a quick look at some things that caught my eye over the past week…
    FMF has some tips for saving on kids clothes. With four boys running around the house, we need all the help we can get!
    A guest blogger over at pfBlueprint wonders al…

  7. nk Says:
    August 18th, 2006 at 10:36 am

    DCA works not only for investment, but even for withdrawl. So, this needs to be compared with a bigger spectrum. Secondly, how to judge right day to invest bulk? Instead periodic investment at least gives a mental peace to some extent.

  8. Jack Says:
    January 8th, 2008 at 9:14 pm

    You blowhards (with the ONLY exception being Nick’s point #3) take the USA today column, impose a new set of assumptions on his analysis, and then pillory him.

    Clearly what he said is invest as much as you can as soon as you can. This is certainly congruent with making a monthly contribution of from your paycheck. What you shouldn’t do is only invest a portion of that contribution.

    If you want more proof that DCA is for suckers check the following academic articles.

    - George M. Constantinides. “A Note on the Suboptimality of Dollar-Cost Averaging as an Investment Policy.” Journal of Financial and Quantitative Analysis. XIV, June 1979, pp. 443–50.

    - Kirt C. Butler and Dale L. Domian. “Risk, Diversification, and the Investment Horizon.” Journal of Portfolio Management. Spring 1991, pp. 41–47.

    - Richard E. Williams and Peter W. Bacon. “Lump Sum Beats Dollar-Cost Averaging.” Journal of Financial Planning. Volume 6, Number 2, April 1993, pp. ?

  9. Andy Says:
    December 23rd, 2010 at 8:30 pm

    I’m a big believer in dollar-cost averaging, though admittedly in practice I do a modified form of it… I buy more aggressively when the market is low and everyone is talking of doom and gloom. When the market is high and happy I cool off on stocks slightly and tend to put more money toward stable value.

    The thing about lump sum investing is that it is critical to time the market correctly, which is a bit tricky. With dollar cost averaging, you can’t miss the bottom with at least some of your money.

    But here’s the thing: If I had a lump sum to invest, that means I would be artifically high in cash and low in stocks, by definition. Therefore, putting the money into stocks would be the equivalent of a rebalance. I probably wouldn’t put it all into stocks all at once, but I would put in a high percentage of it. My goal is to be roughly 90/10 in stocks and stable value, although I change this according to market conditions (selling high/ buying low). If a lump of cash suddenly fell out of the sky into my bank account, I wouldn’t be 90/10 anymore and I’d want to rebalance to fix that.

    (All that said, I’d actually probably use it for a recast on my mortgage to lower my payment to something more reasonable)

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