Dollar Cost Averaging—Myth vs. Reality

Many of us are familiar with the concept of dollar cost averaging (DCA). While specifics may vary, it involves investing a fixed dollar amount at regular intervals over a specified period, and is contrasted with lump sum investing (LSI), or investing all at once.

Dollar Cost Averaging vs. Lump Sum Investing

A popular notion has it that DCA is somehow beneficial to investors because it allows them to buy more shares when prices are low and fewer shares when prices are high. Does academic research bear this out? These titles of academic papers are pretty clear about the answer:

A Note on the Suboptimality of Dollar-Cost Averaging as an Investment Policy1

Nobody Gains from Dollar Cost Averaging: Analytical, Numerical and Empirical Results2

While there may be some emotional appeal to the idea of not committing too much in case the market goes down, it should be intuitive that with a market that goes up over time and offers a premium for being in stocks and bonds, the best chance for success lies with lump sum investing (LSI). In a July 2012 paper (“Dollar cost averaging just means taking risk later”), Vanguard concludes:

“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…the prudent action is investing the lump sum immediately to gain exposure to the markets as soon as possible.”3

That is not to say that LSI outperforms or will outperform over all periods—DCA has done better in market downturns. If a very nervous investor wants to dip a toe rather than dive headfirst into the investment waters, DCA may be appropriate:

“…if the investor is primarily concerned with minimizing downside risk and potential feelings of regret (resulting from lump-sum investing immediately before a market downturn), then DCA may be of use. Of course, any emotionally based concerns should be weighed carefully against both (1) the lower expected long-run returns of cash compared with stocks and bonds, and (2) the fact that delaying investment is itself a form of market-timing, something few investors succeed at.”

Of course, investors who contribute a portion of each paycheck to a savings or retirement account are doing their own form of DCA, and much of the popular writing about DCA is in this regard. But that is different from holding back available cash from going into a target asset allocation.

Transaction costs involved with DCA steps are another consideration. In transaction-based accounts, the more DCA steps, the higher the cost to the investor (brokers must love DCA!).

So what does this mean for investors? Bottom line is that likely for the vast majority, LSI into an asset allocation that appropriately reflects their objectives and risk tolerance is the way to go. If the investor is very resistant to using LSI in these situations, it might be wise to take another look at whether the allocation is indeed appropriate given this reluctance.

One potential use for DCA is for investors receiving a big lump sum, relative to net worth, e.g., selling a business. Someone who is new to being a big investor may panic if there is an initial market downturn that causes large losses in dollar terms. DCA may help the transition and support ongoing investment discipline for these investors.

 

Hewins Financial Advisors, LLC d/b/a Wipfli Hewins Investment Advisors, LLC (“Hewins”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Hewins is a proud affiliate of Wipfli LLP. Information pertaining to Hewins’ advisory operations, services and fees is set forth in Hewins’ current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. The views expressed by the author are the author’s alone and do not necessarily represent the views of Hewins or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Hewins, and Hewins does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Hewins of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional. Hewins does not provide tax, accounting or legal services.
Martha Post
Martha Post

CFA | Principal, Chief Operating Officer

Martha Post, CFA, is a Principal and the Chief Operating Officer for Hewins Financial Advisors, based in Redwood City, CA. Martha oversees Hewins' operations and client service activities and also serves as a member of its Investment Committee, with nearly 30 years of experience in investment management, research and analysis.

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Dollar Cost Averaging—Myth vs. Reality

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