I always thought DCA was the best way to invest over the long-haul, this article says it’s not.
From personal experience I can tell you that DCA is probably best for the average investor. I’ve tried timing the market and didn’t get very good results. The stock market is nothing if not unpredictable. If there were a sure fire way to maximize return on investments, it would have somehow to get around that unpredictability.
I heard somewhere that there is/was a monkey that picked stocks by throwing darts at a sheet of paper listing the NYSE offerings. His picks performed better than the S&P500. Whatever.
The *Wall Street Journal * had a long-running feature called “Investment Dartboard” on exactly this theme - each round would compare the performance of four stocks picked by four professional investors to the performance of four shares selected by the newspaper’s staff, who really did throw darts at the listings to make their selections, IIRC. I don’t know if the *Journal * is still running “Investment Dartboard.”
And here I expected to find the cost of operating sites like Snopes etc…
I don’t recall the exact method, but the monkey worked for the Chicago Sun-Times. Apparently this is the third or fourth year they’ve done it. IIRC the first year went very well and the next two were OK and he really blew it this year.
Sounds like a typical fund manager to me.
I guess I missed it in the article—what the hell is DCA? It says that it is not the same as buying at set intervals. If it is not the same as buying at set intervals, then what is it? Are DCA and market timing mutually exclusive?
I’m not a financial expert, but I think what the author of the article meant is that DCA is investing your money incrementally over time, specifically for the (alleged) purpose of smoothing out market volaitility. In other words, you’ve got $2,000 up front, but rather than just write one big check for $2,000 to the IRA people, you write a check for $166.67 on the first of each month. (Or alternatively, you write one big check, but with instructions to the IRA people to park it in something like a money market fund, and move $166.67 of it over to the stock mutual fund each month).
By contrast, if you’re having $166.67 withheld from your paycheck and put into your 401(K) plan every month, you’re not necessarily trying to do dollar-cost averaging–if you had the entire $2,000 up front, you might happily invest it all in one lump on January 1; you’re just putting in smaller amounts on a set schedule because like most of us that’s how you get money in the first place, in smaller amounts on a set schedule, instead of a great big annual paycheck.
Yes, they are mutually exclusive.
As the previous poster noted, DCA is when a set amount is put into an account at a set time. The idea being that market timing is too difficult for the average investor (and for most, if not all, managers/pros as well) to work out and by putting X at set intervals the money will be put in peaks as well as troughs, but the prices will average themselves out quite nicely and the investor see a higher return than if the tried to invest thinking that 10,000 was a solid bottom to the DJIA or waiting for it to hit 9000 again and never getting in. Through DCA, he would (theoretically) invest at both 10,000 and 9,000, giving him an average entry of 9,500.
IMO, it’s a way for Wall Street to suck more money out of investors and give them a false sense of security, but they gotta do something now that it’s finally illegal to operate stocks.*
- Operate in the Jesse Livermore sense.
That article uses some pretty shaky logic in my opinion. It’s entirely possible that the research does show exactly what the writer tries to impart with examples, but the examples he gives are very misleading.
He gives you an example year, in which the market trends upward. You don’t need a degree in economics to understand that in a rising market, investing early is better. What’s completely absent from this example is how these things fare in a falling or fluctuating market (where DCA will perform better) , and the relative likelihood of each weighted together.
Completely meaningless? What if you had invsted the day after. You’d be doing even better! What if you had started a DCA investment program that day instead of investing the whole thing? Also better. The comparision with the money market fund isn’t meaningful, either. DCA does not mean keeping money in a money market fund for 20 years.
Either way, I imagine it’s academic for most of us anyway. We haven’t got $Large sum of money to invest, we’ve got $Small amount each month.
Well, there you go.
BTW I thought stock movements were generally log-normal, so why would it matter at all? If I have ten stocks at 1 vs. one stock at 10, a 10% movement is going to effect me the same regardless: 10¢ × 10 = $1 × 1, right?
DCA sounds like financial homeopathy—no medicine, but no toxins either.
A friend of my father was investing in a particular stock a few years ago (I don’t know which one) and had evidently spent about $1500 after which the price dropped, so he spent another $1500, after which it dropped further and he spent another $1500. He figured that at that point it would only have to increase in price by a relatively small amount to recoup his investment. It makes some sense, except for the fact that the price had been falling so much that it seemed like it would just be highly unlikely he’d ever recover.
I don’t know if he ever did.
I’d say that the example given in the Middleton article was pretty much useless. Of course DCA looks bad when using the single example of a single stock that rose over that period of time. In order to prove his point, he really needs to use numerous stocks over numerous periods of time, in rising and falling markets. Then he’d see the value of DCA.
Of course, you can check this for yourself. Look at a chart of a stock’s price over 10 months) which is what he used. Now run a moving average over that same time period. The moving average will be average price that you’d be buying by using DCA. Now look at the periods in which the moving average is below the actual stock price. If you would have purchased at any of these times in a lump sum, you’d lose. Remember to do this same analysis for several years, and not just a rising year.
No cite, but it’s a generally well-known fact that no one can accurately time the market with any degree of certainty. You can get lucky, but over time you’ll even out. If you’re investing your entire life savings, don’t take chances. Use dollar cost averaging.
The thing that bothers me skimming the article is that DCA has always seemed to me to be a simple strategy for the investor who wants to make a minimal effort for keeping track of investments, but market timing is a strategy used by people who invest a great deal of time, effort, and research into following the market and their investments. So, not only are the techniques different, the populations who are willing to use either strategy are mutually exclusive.
In other words, whether the argument presented in the link is accurate or not is immaterial: most of the people who DCA have neither the time, nor the desire to seriously use market timing. For the casual invester DCA is a reasonable strategy to follow to avoid being burned by market fluctuations. And no amount of min/max-ing will change that.
" … in reality, security prices rise more frequently than they fall, by a margin of about two to one."
I think this is the crux of his argument. I don’t know how he formed this generality, or what kind of time-frame he is considering.
If we accept as a given that market timing will do no better than chance, then the benefit of dollar cost averaging is simply to reduce variance. If you invest it in a lump, that lump may do much better than average, or much worse. It’s simply a way of mitigating risk.
Another flaw in the argument: he’s comparing ten “random” investments to four DCA investments. Basic math: the more data points, the closer the fit to the curve. And if the curve is showing an 11.7% growth over the year (the single investment is hardly an argument for or against anything), then the more points, the closer you’re going to get to that curve. He needs to compare twelve monthly investments to twelve random investments; I’m betting they difference would be negligible.
In addition, though the percetanges seem to mean something, the total difference between random and the quarterly is only 0.7% – it looks like more because the percentage for the random investment happens to be expressed as two digits. A 9.9% to 9.2% difference would not look as impressive.
Finally, his “random” investments are just another form of DCA. He’s keeping the most essential part: investing a set amount regularly. He’s only changing the intervals, not the strategy.
DCA is a bad method of investing if
- you know what your investment is going to do in advance
and - you have your entire sum to invest at once
yeah…if we were all psychic, we would buy when the market is low and sell when it is high.
I would guess that he is looking at the long term performance of any of the standard indexes.
Here’s the thing. Professional stock pickers (IOW stockbrokers, fund managers, etc) don’t know what stocks will do any more than anyone else does unless they are involved in some kind of insider trading. They can figure out which companies are likely to be successful or which ones are in trouble, but as my friend who is a hedge fund trader says “if I knew what the market was going to do, I would just stay at home and pick winners and never work”. No amount of research or charts and graphs can tell you what a stock will do because past history does not determine future performance.
They make money when you buy or sell the stocks, not by guessing correctly. Fund managers pick a group of stocks or other equities in such a way to limit risk. They go short on industries or companies they think are in trouble and long on companies or industries they expect to do well. They invest in a portfolio of stocks so that a slowdown in one sector of the economy won’t clean them out. The downside is that you don’t earn as much as you would had you picked only the top performing stocks. Of course, you don’t know what those will be.