Finally! Can we lay DCA to rest and ban this topic forever?

[Lbill]

Larry Swedroe has written an excellent piece on dollar cost averaging that should be the singular response to all future "Should I invest my x$&# all at once or DCA?" threads.

http://moneywatch.bnet.com/investing/blog/wise-investing/dollar-cost-averaging-does-it-produce-better-results/3026/

The bottom line is that while there’s no logical reason to DCA (as it’s an inferior approach), DCA may still serve a purpose. If you are so risk averse that you would not invest if you were forced to choose between investing a lump sum or not at all, DCA becomes “the lesser of evils.”

That's all there is to say about the topic - period.

[cyclysm]

What if you're planning to move a large sum of money into Treasury bonds? The study referenced in Swedroe's post only looked at the S&P 500.

[Opponent Process]

it will never go away because you'll always have a mix both logical and emotional investors, and you can't force someone to be logical. you'll always have people that understand portfolio management and those who cannot or will not, and instead implement various timing tricks to try and manage risk instead of using a suitable portfolio for this goal. in the end the DCAer will be lump summed anyway, so gaining some knowledge about portfolio construction is always warranted and indispensable for successful long-term investing.

[bertilak]

SEE MY LATER POSTS FOR A CHANGE OF HEART!

Two quotes from the article:

The lower volatility investors experience could explain the popularity of the strategy [DCA].

... there’s no logical reason to DCA ...

I believe the first quote shows why the second quote is wrong. Lower volatility is generally considered a good thing -- it is the main reason we diversify. It is not just an "emotional" issue as the article claims. DCA diversifies across time.

All the study shows is that a more risky plan has a higher expected return than a less risky plan, but we all knew this already.

I think DCA makes sense whenever moving a significant amount between holdings of significantly differing volatilities.

Almost everyone does DCA anyway since almost everyone invests piecemeal as funds become available.

[livesoft]

Sorry, but please put things in perspective ...

The average outperformance was 1.3 percent.

That's not gonna make anybody justify LS versus DCA. For a mere possible cost averaging 1.3% about 64% of the time, one can DCA. (That's 0.83% 100% of the time.)

That cost is less than the expense ratio of many actively-managed funds or less than the fees charged by many advisors using index funds or less than a single volatile down day in the stock market.

Please move along folks, nothing to see here.

[Opponent Process]

don't get it twisted. the question under discussion is whether DCA produces better results. the answer is no.

[xerty24]

Lower volatility is generally considered a good thing -- it is the main reason we diversify. It is not just an "emotional" issue as the article claims. DCA diversifies across time.

Sure - you can hold all cash too and have very very low volatility, and you can even diversify between several different FDIC bank accounts. But you aren't going to make more than 1%/year doing it and stocks have paid a lot better than that on average - that's what people think who buy stocks anyway. So my point is that

1. IF you think stocks are a good bet for the long term, AND
2. you have the money to invest now, AND
3. you don't think you have any ability to time the market

THEN

4. DCA is clearly a worse approach on average.

DCA is only "right" when the market falls, and surely you must think it's more like for the market to rise than fall or why would you invest? It's not just a bad idea, it's internally inconsistent logic.

DCA is designed to minimize regret and but also minimizes returns. If you're willing to put 50% of your money in stock, why put it in 10% per month? It's not because of risk aversion or you'd put in less than 50% overall. In short, I think the risk you avoid by DCA'ing is a bad bet and consequently you'd be better served putting all your money in at once. If you think that's too risky, you should put a smaller amount of money in, all at once, rather than DCA'ing.

[Xile F Investor]

I actually prefer value averaging, because it fits in well with my re-balancing strategy.

In terms of DCA vs. Lump Sum. If you have the money, put it in, if not, put it in as you have it (DCA). If its long term, then don't try to time the market, the gains will come, in the long term.

[bob90245]

Larry Swedroe has written an excellent piece on dollar cost averaging that should be the singular response to all future "Should I invest my x$&# all at once or DCA?" threads.

http://moneywatch.bnet.com/investing/blog/wise-investing/dollar-cost-averaging-does-it-produce-better-results/3026/

The bottom line is that while there’s no logical reason to DCA (as it’s an inferior approach), DCA may still serve a purpose. If you are so risk averse that you would not invest if you were forced to choose between investing a lump sum or not at all, DCA becomes “the lesser of evils.”

That's all there is to say about the topic - period.

Sure, only if you misinterpret the evidence, which Larry did.

A portfolio with $1 million was to be invested in the S&P 500 either according to DCA or all at once. (Transactions costs were ignored, which favors DCA’s additional trading.) The portfolio following DCA invested 1/12th at the beginning of each month. The study covered rolling 20-year periods from 1926 through 2010.

Investing all at once [lump sum] was the better strategy in 552 of 781 possible periods — more than 70 percent of the time.

Not exactly a ringing endorsement for lump sum. The most you can say is that you are playing the odds (7 out 10) that lump sum will provide higher terminal value over the long haul.

[lightheir]

Just a question - wouldn't the timing of the lump sum investment (on a dip versus a record high) impact the results? Or is it not a significant effect over the period of time examined?

[larryswedroe]

There are some issues in finance that are debated, like source of value premium. DCA was put to bed by academics over 45 years ago with Constantinides paper. None has disputed it. No one even discusses it as considered long settled.

[livesoft]

But suppose the benefit of LS was not 1.3%, but was only 0.2%, would you still be touting LS beats DCA? While it is technically correct that LS beats DCA, the cost of DCA may be miniscule compared to the value received.

[dmcmahon]

12 months is not long enough IMO to DCA. The comparison should have been over a longer period, e.g. 20% per year for 5 years.

[Opponent Process]

how about 5% per year over 20 years? to an OCD patient, the cost of washing hands 100 times a day may be miniscule compared to the value received, but to encourage this irrational behavior is wrong IMO.

[tfb]

The debate never ends because the case for DCA keeps presenting itself. Suppose you were going to lump sum the IRA contribution on Jan. 2 this year. Would you be better off with DCA this year?

Or dare I say just wait? I think livesoft once looked at it and found that the low in a year almost always occurs after Jan. 2. So you set a limit order at X% below the price on Jan. 2. Boom, you just beat the market. If it wasn't livesoft, I apologize for mis-attributing the finding.

[RobG]

I think livesoft once looked at it and found that the low in a year almost always occurs after Jan. 2.

How long did it take for him to figure that one out?

[yobria]

Yep, exactly right, no logical reason to DCA if prices move randomly.

So why do we hear so much about the wonders of DCA?

The answer lies in an mathematical quirk that sounds good but doesn't buy you anything in reality (kind of like the "rebalancing bonus") - that with DCA you'll buy "fewer shares when prices are high, and more when prices are low".

That's true, but so what? You got fewer shares when prices were high, but they were high because each share was more valuable.

This is true in a random walk world. In an RTM world, you might get some benefit, as prices obediently bounce back to high prices from low ones. I wouldn't count on an RTM world, however.

Nick

[Fallible]

Larry Swedroe has written an excellent piece on dollar cost averaging that should be the singular response to all future "Should I invest my x$&# all at once or DCA?" threads.

http://moneywatch.bnet.com/investing/blog/wise-investing/dollar-cost-averaging-does-it-produce-better-results/3026/

The bottom line is that while there’s no logical reason to DCA (as it’s an inferior approach), DCA may still serve a purpose. If you are so risk averse that you would not invest if you were forced to choose between investing a lump sum or not at all, DCA becomes “the lesser of evils.”

That's all there is to say about the topic - period.

The Wiki has an excellent article updated and expanded this summer to pull together just about all the pros ad cons of DCAing.

[Bungo]

So, 70% of the time it was better to invest all at once than to DCA. That means 30% of the time it wasn't better. This would be a good argument in favor of all-at-once *if* there's no way to identify at the outset whether conditions appear favorable one way or the other.

But what if you had a lump sum that you wanted to invest near the peak of an obvious stock mania, e.g. 1999, when stock price multiples are at nosebleed levels? Do we have enough data points to know whether dollar cost averaging is the better choice in such a situation? Common sense would seem to suggest so, but what about the numbers?

At least the DCA option exists for stocks. It would be great if it existed for houses. I avoided buying during the mania, which is probably the best investment decision of my life thus far. I wouldn't mind buying now except I think prices are likely to keep falling for several more years (in California). If I could DCA over the next 5-7 years, I'd probably pull the trigger anyway.

By the way, do those who believe DCA is inferior always front-load their 401(k) contributions by diverting 100% of their income for the first few months until the cap is reached? I've done that several times in the past but I have discontinued the practice the last few years because the market has been so volatile that I figured DCA would be better/safer.

[ftobin]

It's curious to note that the study only used investing on the first of the month. If I recall correctly, there are well-known effects similar to the January effect where investing on the first of the month has drastically different returns from investing on other days.

Trading and other costs aside, handling a large position I would rather get in over a period of days rather than just one day. Same reason why people like VWAP orders. Diversify your get-in.

[zeugmite]

By the way, do those who believe DCA is inferior always front-load their 401(k) contributions by diverting 100% of their income for the first few months until the cap is reached? I've done that several times in the past but I have discontinued the practice the last few years because the market has been so volatile that I figured DCA would be better/safer.

Well, there you go. It is all related to risk/volatility. People are comfortable lump-summing when volatility is low and prefer DCA when volatility is high. Can you blame them? If you have a set risk preference then this is completely rational.

When prices vary by several years worth of expected return within just a few days, I think a short period of DCA of a few months is a reasonable period to diversify over. This additional variance is not trivial. If you accept a certain amount of variance on yearly returns in setting up your portfolio, why would you be happy to add so much back in on the initial buy?

[tfb]

I think livesoft once looked at it and found that the low in a year almost always occurs after Jan. 2.

How long did it take for him to figure that one out?

It's actually not as intuitive as you would think. If it can be shown there is a high enough probability (e.g. to the tune of 70% as in the study cited by the article in the OP) that a price X% lower than the current price will emerge in the next 12 months, a strategy of waiting up to 12 months for a price X% below the current price would win over lump-sum investing on day 1, and by extension win over DCA if the study is held true.

[petrico]

don't get it twisted. the question under discussion is whether DCA produces better results. the answer is no.

Actually, it seems the question of whether DCA produces better results is getting twisted with a truly valid purpose of DCA: risk reduction.

What would a similar analysis show about the use of fixed income in a portfolio?

At 15% or more, my guess would be an allocation to fixed income investments would be shown to be an "inferior" strategy to 100% equity. Should we also hold no bonds, because the expected return of 100% equity can be demonstrated to produce superior returns most of the time?

Is that not the same logic?

Is accepting lower expected returns for lower risk never appropriate?

Is it "illogical" to hold any bonds? Is any fixed income allocation only justifiable for the emotionally weak?

All the study shows is that a more risky plan has a higher expected return than a less risky plan, but we all knew this already.

Exactly, bertilak! This whole "outperformance" argument for lump summing is baffling in its complete disregard for risk.

--Pete

[grayfox]

Like everything, there's a time to DCA and a time to lump sum. [See Ecclesiastes 3:1-15]

If trying to decide whether to lump sum or DCA, first I would say look at expected return, E(return). For bonds, E(return) is just YTM. For stocks, you have to estimate E(return), maybe from dividend yield or earnings yield (inverse of P/E10). If expected real return meets your requirements, then lump sum in immediately. For instance, if your required real return is 2% and expected return is 2.5%, then lump sum. You've locked in your required return and you're done.

If expected return doesn't meet you requirements, you wouldn't want to lump sum in because you will be locking in at an expected return that does not meet your requirements.

For bonds, you can either wait for higher yields that meet your requirements or begin DCA'ing at the lower yields and hope that the rates rise.

For stocks look at volatility (VIX and momentum (200-day SMA). If volatility is high and momentum is negative, then maybe it's worth the gamble to DCA.

[dgm]

don't get it twisted. the question under discussion is whether DCA produces better results. the answer is no.

I think you have to factor in human psychology.

every time someone asks me if they should put their money in the market, it is (in hindsight) close to or near the peak....because thats when they feel like things are safe or they might be missing out.

So i think there is an argument to be made for dca to avoid inadvertently timing the market.

[petrico]

If volatility is high and momentum is negative, then maybe it's worth the gamble to DCA.

The wording is curious, given the fact that DCA is actually a means of reducing the risk of loss*.

But I guess one could also say, "If your need to take risk is high because you are far from your goals, but your ability to withstand loss is low, then maybe it's worth the gamble to hold some bonds."

*This is true not due to the time out of the market, but to the "diversification" of purchases among 6-12, or what have you, purchase prices.

--Pete

[grayfox]

If volatility is high and momentum is negative, then maybe it's worth the gamble to DCA.

The wording is curious, given the fact that DCA is actually a means of reducing the risk of loss.

But I guess one could also say, "If your need to take risk is high because you are far from your goals, but your ability to withstand loss is low, then maybe it's worth the gamble to hold some bonds."

--Pete

Suppose that your minimum required return is 2% and the expected return is currently 3%. If you lump sum in immediately, you are buying in at a level that meets your requirement. If, instead, you DCA over 12 months, there's a chance that price increases and expected return goes below your requirement. So it seems that in this case, there is greater uncertainty with DCA. More of a gamble.

[dickenjb]

What if instead of being risk averse you were risk adverse? I see a lot of posters on this board who consider themselves risk adverse and maybe for them DCA makes sense.

[baw703916]

I agree that under almost all circumstances DCA has a net negative return. But...

Let's say you received a lump sum from say, an inheritance, which you planned to invest. This happened in the Sept.-Oct. 2008 time frame, right when the Dow was fluctuating by several hundred point every day, oscillating wildly but mostly seeming to be heading down. It's also clear that there's a lot of stuff going on in financial markets that nobody seems to understand...

Does deciding to not jump in all at once and deciding to DCA over a few months really sound like a terrible idea under these circumstances?

This did in fact happen to me. Under "normal" circumstances I would just lump sum, but decided not to jump in all at once in that instance.

Brad

[larryswedroe]

The longer the period the WORSE DCA looks because there is an ERP that you forego. Again, this has been a settled issue in finance for almost 50 years

[TrustNoOne]

it will never go away because you'll always have a mix both logical and emotional investors, and you can't force someone to be logical. you'll always have people that understand portfolio management and those who cannot or will not, and instead implement various timing tricks to try and manage risk instead of using a suitable portfolio for this goal. in the end the DCAer will be lump summed anyway, so gaining some knowledge about portfolio construction is always warranted and indispensable for successful long-term investing.

I grant that DCA is an emotional rather than logical choice. My question is what about asset allocation? Isn't that pretty much an emotional decision. Risk tolerance- isn't it also driven by emotion as well? So if you are heading for an emotional target, what difference does it make how you get there? (BTW - aren't the purely rational investors the ones asking what's wrong with 100% stocks 100% of the time?)

[Dandy]

I generally agree that lump sum will outperform DCA most of the time. But a 60% equity allocation will outperform a 40% allocation most of the time. Does that mean everyone should have 60% or 80% ? Stocks over time outperform bonds?

So, to me the people who DCA (and are aware of the Lump sum advantage )are making a trade off between some extra gain vs risk. It fits their risk tolerance just like a 40% equity alloction might vs a 60% allocation.

I'm not sure what timeframe was studied for DCA. The shorter the DCA timeframe the less performance difference - I assume.

[larryswedroe]

Clearly DCA lowers risk, as does a lower equity allocation. So the question is which is your goal. If it is to achieve the highest expected return than DCA makes no sense. If you want to reduce your risks, than DCA does, as does a lower equity allocation. The question really is which is the strategy most likely to allow you to achieve your goal? If risk reduction allows you to stay the course and actually invest, not being paralyzed by the fear of investing in lump sum at the wrong time, than DCA makes sense. Otherwise not.

[bertilak]

I generally agree that lump sum will outperform DCA most of the time. But a 60% equity allocation will outperform a 40% allocation most of the time. Does that mean everyone should have 60% or 80% ? Stocks over time outperform bonds?

So, to me the people who DCA (and are aware of the Lump sum advantage )are making a trade off between some extra gain vs risk. It fits their risk tolerance just like a 40% equity alloction might vs a 60% allocation.

I'm not sure what timeframe was studied for DCA. The shorter the DCA timeframe the less performance difference - I assume.

Very concise and to the point.

Seems that every objection to "DCA reduces risk" is "DCA is inferior because it has a lower expected return", ignoring the point in question. The article linked to in the OP even states that DCA lowers volatility but dismisses that as an emotional issue. That surprising assumption goes unexplained, even after being brought up multiple times.

It's as if the "expected return" drumbeat is intended to drown out the actual claims for DCA.

I would be happy to consider arguments that challenge the lowered risk claim, either disproving it it or showing that the risk/reward tradeoff is not justified (ever?) but no one makes that kind or analysis.

AND THOSE ARGUMENTS WERE MADE AND I FOUND THEM PERSUASIVE. SEE LATER POSTS.

[bertilak]

If risk reduction allows you to stay the course and actually invest, not being paralyzed by the fear of investing in lump sum at the wrong time, than DCA makes sense. Otherwise not.

Am I "paralyzed by fear" because I have bonds in my portfolio?

[Opponent Process]

If risk reduction allows you to stay the course and actually invest, not being paralyzed by the fear of investing in lump sum at the wrong time, than DCA makes sense. Otherwise not.

Am I "paralyzed by fear" because I have bonds in my portfolio?

why in the world would you have bonds in your portfolio if DCA is a better way to manage risk? DCAers need to explain why they simply wouldn't use an appropriate portfolio to manage risk.

[MarcMyWord]

don't get it twisted. the question under discussion is whether DCA produces better results. the answer is no.

For many people, DCA produces better psychological results, in terms of allowing them to stick to a plan without fretting about whether they got a "good" or "bad" price on a single lump sum purchase. I'm one of them.

I had to "lump sum" my house, a long–term holding bought at a single day's market price. I had to "lump sum" my car. And so on. I'd rather not lump sum things that I don't have to lump sum. It's an admission to myself that in something with as many variables, and as much unpredictability and fluctuation and excitability, as financial markets, I'll only know with eventual hindsight exactly what turned out to be good or bad prices.

Marc

[tadamsmar]

DCA does cause risk reduction and risk inconsistency. You risk slowly goes up over the period when you are DCAing.

You can achieve the same overall risk reduction by simplying adopting a more conservative AA. This avoids risk inconsistency.

Therefore, DCA is not necessary for risk reduction and it is not the optimal way to achieve risk reduction.

[tadamsmar]

Why not use reverse DCAing? You put the lump sum in stocks on day one and slowly pull it out, simply reversing the DCA schedule. Then at the end you put the lump sum all in again.

How would reverse DCA be different from DCA?

I don't see how one is any better than the other.

[bertilak]

why in the world would you have bonds in your portfolio if DCA is a better way to manage risk? DCAers need to explain why they simply wouldn't use an appropriate portfolio to manage risk.

Why diversify US vs. International if you are already diversified stock vs. bond?

[natureexplorer]

There is no question that from a purely statistical point of view, the odds are in your favor with a lump sum. But, what if you you are wrong? DCA increases the likelihood of you as an individual actually having average returns. It reduces the dependence of your returns on your starting point in time.

Investing a huge lump sum at once is in a sense like investing in individual stocks. The "expected" return of an individual stocks is the same as that of the market (depending on the risk). However, the likelihood of you to underperform the market is now 50%.

Similarly, DCA is time diversification. Unfortunately, this diversification comes at the cost of the cash drag. So, one is actually compensated for not diversifying time. Whether this compensation is worth it to you is a personal decision and also has a lot to do with good self-perception.

[Opponent Process]

why in the world would you have bonds in your portfolio if DCA is a better way to manage risk? DCAers need to explain why they simply wouldn't use an appropriate portfolio to manage risk.

Why diversify US vs. International if you are already diversified stock vs. bond?

this has nothing to do with my point. my point is that I use a portfolio to manage risk. not timing strategies. do people not notice that a large portion of the Boglehead message is portfolio construction and management? you don't have to go about investing so blindly. why not spend some more time understanding what you're investing in? do you not realize that all of the money you have invested right now is a lump sum? how are you currently managing the risk of this lump sum?

[Lbill]

My guess is that most financial advisors would tell you to DCA - not because it's good for you, but because it's good for them. If they advised a client to lump sum, and the market immediately went down, what do you think the client would do with his account? So, don't listen to most financial advisors on this topic - even if they know the truth they're not going to tell you.

[dmcmahon]

how about 5% per year over 20 years? to an OCD patient, the cost of washing hands 100 times a day may be miniscule compared to the value received, but to encourage this irrational behavior is wrong IMO.

I am very glad that I chose to DCA over many years rather than go all-in in 2005/2006. My choice was driven by valuation concerns. Every position taken since then is currently underwater. Thankfully, the losses were smaller than they'd otherwise have been with the full AA, and I had those extra years of CD and bond interest income.

[larryswedroe]

I tend to agree with your comment.

Here is IMO the right way to look at this:

Simply put, DCA lowers risk and of course lowers expected return. If that is the objective then one should CHANGE THEIR ASSET ALLOCATION, not DCA which is suboptimal strategy.

Now as I said, if DCA helps you from behavioral standpoint, then one should prefer DCA as it will more likely keep you disciplined. Then it makes perfect sense because the right portfolio is the one you are most likely to stick to.

[bertilak]

this has nothing to do with my point. my point is that I use a portfolio to manage risk. not timing strategies.

Hmm, we *were* talking about the legitimacy of using DCA as a risk management tool. I should have noticed that you changed the subject since so many seem to want to do that. Is DCA forbidden as a risk management topic? BTW, I also use diversification of my portfolio's makeup as a risk management tool and have nothing against that.

do people not notice that a large portion of the Boglehead message is portfolio construction and management? you don't have to go about investing so blindly. why not spend some more time understanding what you're investing in?

Thanks, I'll get right on that. Somehow it slipped my mind.

do you not realize that all of the money you have invested right now is a lump sum?

Actually it is not. The funds went into my portfolio over many years at a variety of costs.

how are you currently managing the risk of this lump sum?

I don't have a lump sum of cash at my disposal right now so there is nothing to manage.

[Noobvestor]

I tend to agree with your comment.

Here is IMO the right way to look at this:

Simply put, DCA lowers risk and of course lowers expected return. If that is the objective then one should CHANGE THEIR ASSET ALLOCATION, not DCA which is suboptimal strategy.

Now as I said, if DCA helps you from behavioral standpoint, then one should prefer DCA as it will more likely keep you disciplined. Then it makes perfect sense because the right portfolio is the one you are most likely to stick to.

While I largely agree, there have to be outliers that aren't factored in here. Like: you might be buying in at the absolute peak. Let's say you've won the lottery and it's enough to all-but-retire on, and you have no other savings. Statistically, sure, you will be better off DCAing, but practically speaking, if you happen to invest right at a peak you might still be in that unlucky few percent that does a lot worse for DCAing - is that risk really worth taking?

It reminds me a bit of pro-100%-stock arguments - yeah, the expected return is highest, but the volatility is high too, and there's always the possibility stocks won't recover, etc... etc.. similarly, there's the possibility that you just hit the market at the wrong time and never do as well as you would have spreading out your investment, right? Edit: analogy is slightly flawed I think, per example below. Doh! Might still have some merit, dunno, too early in the morning

[Lbill]

do you not realize that all of the money you have invested right now is a lump sum? how are you currently managing the risk of this lump sum?

This, of course, is the reductio ad absurdum aspect of the DCA argument. If it were such a good method. you should DCA in, convert all your assets back to cash, DCA it back in, etc.

[jhh9327]

Which group would you choose to join in the following scenario?

Group A - Each person in this group flips a coin 10 times. Every flip puts 10% of your original net worth at risk. The first 5 times you flip, your win 3 times your bet if it ends up heads. You lose the bet if you get tails. The second set of 5 flips, heads wins you 2 times your bet and tails continues to lose your bet.

Group B - Each person in this group flips a coin a single time. This flip puts 100% of your net worth at risk. If you flip heads, you win 3 times you original net worth. If you flip tails, you lose it all.

Do we all agree that expected return favors group B? On average, the returns of group B will exceed the returns of group A? Therefore, anyone who would purposely choose to be included in group A over B is making an inferior and illogical choice compared to those who would pick B even though half of group B ends up broke, right?

This example is not meant to say that DCA is better than lump sum. It is to point out that that when you only get one shot at something, there is certainly cases where the logical and rational choice can be going against an alternative that outperforms it on average.

Using average returns as the sole basis to say one choice is logical and the other is not is too simplistic, IMO.

[empb]

do you not realize that all of the money you have invested right now is a lump sum? how are you currently managing the risk of this lump sum?

This, of course, is the reductio ad absurdum aspect of the DCA argument. If it were such a good method. you should DCA in, convert all your assets back to cash, DCA it back in, etc.

This exactly. DCA simply fails to hold water.