Dollar Cost Averaging Myth vs Reality

Dollar cost averaging is a popular investment strategy, but is it really as effective as people claim? According to a study, dollar cost averaging can actually lead to lower returns over the long term.

Investors who use dollar cost averaging tend to invest smaller amounts of money at regular intervals, which can result in buying more shares when prices are high and fewer shares when prices are low. This can be a problem, especially in rapidly rising markets.

In fact, a study found that investors who used dollar cost averaging during the 2008 financial crisis ended up with lower returns than those who invested a lump sum. This is because they were buying more shares when prices were low and fewer shares when prices were high.

The evidence is clear that using DCA does not stack the odds in your favor. In fact, a 1979 paper declared DCA "suboptimal."

A more recent examination of this question found that investing a lump sum came out ahead almost exactly two-thirds of the time over rolling 10-year periods in the U.S., United Kingdom, and Australia. This was for a portfolio of 60% equities and 40% bonds.

DCA does not produce higher returns in a significant majority of scenarios. A 1993 paper found DCA produced higher returns in just 27% to 39% of the scenarios it tested.

Using dollar-cost averaging (DCA) doesn't give you an edge over lump-sum investing, and in fact, the opposite is true.

A 1979 paper declared DCA "suboptimal", a result that was later confirmed by a 1993 paper that found DCA produced higher returns in just 27% to 39% of the scenarios it tested.

Investing a lump sum has been shown to be a winning strategy, coming out ahead almost two-thirds of the time over rolling 10-year periods in the U.S., U.K., and Australia.

Research by Vanguard found that lump-sum investing outperformed DCA over 12 months in all three countries, with a portfolio of 60% equities and 40% bonds.

In a Vanguard paper, "Dollar-cost averaging just means taking risk later", the researchers ran the numbers using DCA periods from six to 36 months, and various mixes of stocks and bonds, with similar results.

Using DCA does not stack the odds in your favor; on the contrary, lump-sum investing is at least a two-to-one favorite.

A more interesting claim for dollar cost averaging is that regular investors will tend to do better over the long term if they put their money into more volatile investments.

Research has shown that this is indeed the case, with simulations revealing that as volatility increases, the final return on average also increases.

However, it's essential to note that this doesn't mean more volatile investments are always better, and the results are not guaranteed. In fact, more volatile investments can have lower returns, even after 200 years of investments.

The key takeaway here is that a bit of volatility in investments can be beneficial for regular savers, but it's crucial to remember that dollar cost averaging generally reduces returns over lump sum investing.

Investing a lump sum in a volatile investment would have yielded a staggering $99,988,880,689, compared to the $5,977,271,217 achieved through dollar cost averaging.

This highlights the importance of considering the potential risks and rewards of investing in more volatile assets, and being aware of the potential consequences of dollar cost averaging.

Most of the time, lump sum investing beats dollar cost averaging. Since 1800, DCA only won 27% of the months.

The data suggests that lump sum investing makes higher returns two thirds of the time. Assuming a 4% annualised return, DCA beats lump sum investing more often, but still not enough to make it the preferred choice.

Lump-sum investing is a straightforward approach where you invest a large sum of money all at once.

Since 1800, lump-sum investing has beaten dollar cost averaging (DCA) most of the time, with DCA winning only 27% of the months.

The S&P 500 is a great example of this, with lump-sum investing outperforming DCA for most of the period since 1970, winning 74% of the months.

In fact, even when we assume that non-invested portions earn a 4% annualised return, lump-sum investing still beats DCA two-thirds of the time.

This suggests that lump-sum investing can be a more effective strategy for long-term growth, despite the potential risks of market volatility.

Since 2000, the trend has been slightly different, with DCA winning 63% of the months, but lump-sum investing still has a clear edge.

Buying the dip is a popular strategy for investors who want to time the market.

It involves purchasing an investment when its price is low, with the expectation that it will rise in the future.

Historically, buying the dip has been a successful strategy for investors who can stomach the volatility.

In the article, we saw that the S&P 500 index fell by 36.5% during the 2008 financial crisis, but it took only 14 months for it to recover.

Investors who bought the dip during the 2008 crisis were rewarded with a 51.5% return over the next 12 months.

However, buying the dip also comes with risks, as investors must be prepared to sell quickly if the investment's price continues to fall.

In the article, we also saw that the average investor who bought the dip during the 2008 crisis would have needed to have a high risk tolerance to withstand the volatility.

As a result, buying the dip may not be suitable for all investors.

If you're extremely anxious about investing a lump sum, dollar cost averaging (DCA) might be a reasonable approach. This is because the fear of regret can be a powerful motivator, and DCA can help alleviate that anxiety.

You'll want to stick to a strict timetable, investing equal amounts each month or each quarter, for example. This is because spreading it out longer than a year will lower your odds of success.

Imagine investing a lump sum just before Black Monday in 1987, or in September 2008 - it's a sobering thought. DCA can help you avoid some of the worst-case scenarios.

Investing in DCA over 36 months resulted in higher returns in just 30 cases out of 493 - a dismal 6% success rate. This is according to a simulation that's worth noting.

If you do decide to use DCA, make sure you're willing to accept the likelihood of lower returns. It's a trade-off, but one that might be worth considering if you're anxious about investing a lump sum.