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

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leonard
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Post by leonard »

So, the final answer on DCA is an article that says you may or may not DCA depending on the circumstance?

btw - I agree with the quote, but anything that says you may do "X" or "Not X" depending on the circumstance isn't the final word on anything.
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Post by umfundi »

Bungo wrote:
umfundi wrote: If you have a lump sum available, trickling your investment over time is NOT dollar cost averaging. It is market timing.
I can equally well argue that choosing to invest a lump sum all at once is an even more glaring example of market timing.
No. If your end goal is 100% invested, why wait?
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Post by chipmonk »

Bungo wrote: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.
Yes, I did it this year and will do it again.

My 401k doesn't allow me to go all the way up to 100% contributions; at the maximum contribution rate, it will take me about 4 months to max out my yearly contribution. My 2012 401k contributions will spend an average of 10 months in the market by the end of the year, rather than 6 months if I DCA'ed smoothly. Rather than hold extra cash, which would negate the benefits, I'll use 0% credit cards and sell taxable bonds if necessary to make up the cash flow shortfall before my 401k maxes out.

My 401k holdings are all bond funds so I don't lose sleep over volatility.
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Finally! Can we lay DCA to rest and ban this topic forever?

Post by iceport »

jhh9327 wrote: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.
jhh9327, great analogy! Thank you. Reduced expected return, and reduced maximum return with DCA. Also reduced maximum loss. (The analogy breaks down on that aspect.)

This really isn't any more a behavioral decision than one's equity/fixed income ratio is. The example above clearly shows that.

It seems odd to see so many people opposed to diversification as a means of reducing risk. In this case, with DCA, we're talking about diversification of purchase prices.

--Pete
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Post by umfundi »

And, I might ask:

What is a lump sum? How does it differ from a periodic sum?

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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by iceport »

Here is an analogy I attempted before on this topic:

Pretend there is a roulette wheel that you can use to purchase into your desired allocation. There are 24 pockets, each with a different weighted portfolio price. You don't know today's portfolio value (if you were already fully invested), and you don't know how each of the 24 pockets compares to today's value. However, you are told that the average of the prices is slightly higher than today's value. (If you purchase at a higher price than today's actual price, you lose money instantly.) There is significant variability among the prices, and 10 of the pockets are priced higher than today's prices, some significantly so. You'd love to be able to pick a pocket that has a price lower than or equal to today's portfolio value, otherwise you lose money. The trouble is, you are at the mercy of the roulette wheel.

You only have two options available to you today for buying into your portfolio:

1) You can place one big bet on one pocket, with your entire lump sum, hoping you get one of the lower prices; or
2) You can spread out your bets equally among all 24 pockets.

Which would you choose?

--Pete
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by Jfet »

petrico wrote: 1) You can place one big bet on one pocket, with your entire lump sum, hoping you get one of the lower prices; or
2) You can spread out your bets equally among all 24 pockets.

Which would you choose?

--Pete
This fails because while you are spending the time placing the bet in each of the 24 pockets, you are missing out on market gains and dividends.

My example of splitting up your lump sum by immediately investing half and selling a cash secured 1 year out put against the other half at least gets you some return in an up market, does better than either method in a flat market, and doesn't have quite the loss of lump sum in a down market.
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Post by bearcat98 »

Buying on the first day of the month over a year may be a normal DCA strategy, but it's not the only one. More frequent installments would seem to avoid the "first of the month" issue, and enhance the "entry point" benefit. Has anyone ever studied the effect of daily vs. monthly DCA installements?

Shortening the period would also mitigate the lost-expected-return disadvantage. 24 installments over five weeks would reduce the time out of the market by about 90% and still give you twice as many entry points.

As for "why don't you DCA what you already have invested," I wonder if it could be made to work. The "mathematical quirk" is that you'll buy "fewer shares when prices are high, and more when prices are low" is real, and should result in a lower average per-share price than the average value of the share over the DCA period (even if the average DCA price is likely higher than the starting price). At the same time, if you sell an equal number of shares each time, your average per-share revenue should be the average per-share value over the period. Therefore, if you start with a 50% stocks, 50% cash, couldn't you sell an equal number of shares each day over a period (thus averaging the average value in revenue), and buy an equal value in shares each day over the same period (at a lower-than-average price), shouldn't you come out ahead at the end of the period? Rebalance, repeat.

So, assuming you can trade that often, why shouldn't you do this to DCA your invested investments?
Last edited by bearcat98 on Fri Oct 07, 2011 6:41 pm, edited 1 time in total.
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iceport
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by iceport »

Jfet wrote:
petrico wrote: 1) You can place one big bet on one pocket, with your entire lump sum, hoping you get one of the lower prices; or
2) You can spread out your bets equally among all 24 pockets.

Which would you choose?

--Pete
This fails because while you are spending the time placing the bet in each of the 24 pockets, you are missing out on market gains and dividends.

My example of splitting up your lump sum by immediately investing half and selling a cash secured 1 year out put against the other half at least gets you some return in an up market, does better than either method in a flat market, and doesn't have quite the loss of lump sum in a down market.
I didn't see your post before, Jfet (I'll ponder that method more), but you are correct about my analogy missing out on the time value. Actually, in my analogy the time element is removed on purpose, but it is accounted for with a higher average price of all pockets.

In real life, the only way to obtain multiple purchase prices is to buy in discrete intervals over some period of time. It's an unfortunate necessity.

--Pete
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by LadyGeek »

Fallible wrote:The Wiki has an excellent article updated and expanded this summer to pull together just about all the pros ad cons of DCAing.
Wiki article link: Dollar cost averaging

It also includes "Reverse dollar cost averaging" which is a periodic distribution. Would the same opinions apply during a withdrawal phase?
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by bob90245 »

LadyGeek wrote:It also includes "Reverse dollar cost averaging" which is a periodic distribution. Would the same opinions apply during a withdrawal phase?
Are you saying that if a retiree starts with $500K in stocks and $500K in bonds, it is better to withdraw the $500K in stocks all at once in the first year of retirement? As opposed to Reverse dollar cost averaging, meaning only withdraw, say $20K from stocks and $20K from bonds, as in the 4% SWR?
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Post by LadyGeek »

I was trying to see if there was any valid point to looking at the converse side of the argument, which I thought was the withdrawal phase (accumulate vs. withdrawal). Maybe this was not the right approach, as you don't spend all your funds in the first year.
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Post by pkcrafter »

Lbill asks:
Finally! Can we lay DCA to rest and ban this topic forever?
Apparently NOT. :?


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Post by umfundi »

My bitch & moan:

Why is it that every discussion in this forum devolves into a belief about market timing, although we all supposedly agree that market timing does not work?

Dollar cost averaging is not a strategy. It is, simply, a consequence of systematic investing. Your average cost is less than the average price.

The complification of this fact is a disservice to less experienced investors. And, the recommended Bogleheads Wiki is, in this regard, wrong.

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Post by kirent »

I think the people who need to DCA are the ones who have failed to set a proper asset allocation. Why compensate for risk twice unless you failed to compensate for it correctly the first time around? If you don't feel comfortable lump summing what you have into the market, then you are obviously at an asset allocation that is too aggressive for you.
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Post by WhiskeyJ »

Here's an example where DCA could make sense. In January this year, a family member of mine with virtually no investment experience asked me for advice on what to do with a lump sum inheritance equal to thier annual earnings. I suggested DCA every week for a year period rather than lump sum, though if it were my money I would have invested lump sum.

Had they invested lump sum, they would have been pretty discouraged at this point and it probably would have negatively impacted thier AA/investing philosophy for several years. Hindsight being 20/20 they got lucky and fell into that rare 30% where DCA was a better choice. For people new to investing, the downside impact of lump sum is likely to have greater negative impact to their investment philosophy than the upside impact of making the optimal statistical choice and being right.
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Post by tadamsmar »

In his article, Swerdroe calls DCA an "inferior approach".

But all he claims in the article is that holding cash underperforms. Is that a news flash? Cash does not have a lower risk-adjusted return than stocks, so holding cash is not an inferior approach.

If Swerdroe was consistent, then he would say that the AA with the highest possible expected return was superior to all others. He would say that holding any bonds was an inferior approach. But Swerdroe is inconsistent.

Performance irrespective of risk is simply not the metric that should be used to determine the best AA.

DCA might be an inferior approach for some other reason, but Swerdroe does not provide any valid reason in the article cited. He needs to rethink the issue and come up with a valid reason.

Edit: by "cash" I mean some interest bearing account that arguably tracks inflation.

Edit: I suppose Swerdroe means to say that it is inferior because there is no logical reason to do it. I can agree with that. There is no logical reason to make your AA temporarily less risky simply because you recieved a lump sum.
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Post by bertilak »

tadamsmar wrote:In his article, Swerdroe calls DCA an "inferior approach".

But all he claims in the article is that holding cash underperforms. Is that a news flash? Cash does not have a lower risk-adjusted return than stocks, so holding cash is not an inferior approach.

If Swerdroe was consistent, then he would say that the AA with the highest possible expected return was superior to all others. He would say that holding any bonds was an inferior approach. But Swerdroe is inconsistent.

Performance irrespective of risk is simply not the metric that should be used to determine the best AA.

DCA might be an inferior approach for some other reason, but Swerdroe does not provide any valid reason in the article cited. He needs to rethink the issue and come up with a valid reason.

Edit: by "cash" I mean some interest bearing account that arguably tracks inflation.
I think you are right that the article did not back the claim that DCA, as a risk management tool, is an "inferior approach" to lump sum investing into a proper asset allocation (because it provides no added value, inferior or otherwise, and it is actually harmful). But, this still leaves open the question of whether or not the claim is true.

At first I was quite sure that the claim was NOT true, but a thought experiment proposed by empb earlier in this thread has planted a seed lof doubt in my head. The experiment is this (fleshed out a bit by me to account for the assumptions I think were implicit at the time of empb's post):
  • Assume you have a desired Asset Allocation already established.

    Assume you already have funds committed to that allocation.

    Assume you receive a windfall of a "significant" size, but no so large that it will invalidate your currently established asset allocation. For example it will not make you put all your money in CDs and move to the South of France to live off the interest.

    Now consider two cases: 1) you receive the windfall as cash, and 2) you receive the windfall as securities already matching your AA. Case 1 is the case where the wisdom of DCA vs LS is at question.
Questions:
  • In case 2 would you liquidate the funds and DCA them back into the AA over time?

    If not, why would you DCA in case 1?

    If so, would you do the same with the funds you already had prior to the windfall? If not, why not?
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by iceport »

From William Bernstein's Efficient Frontier site, we have this:

"Editors Note: Bill Jones is a math professor and frequent contributor to the Mutual Fund Interactive main board. I've seen many analyses of dollar cost averaging versus lump sum investing, but Bill's presentation of the conundrum as an insurance problem was both novel and elegant. With his kind permission EF reproduces it below."

Do Not Dollar-Cost-Average for More than Twelve Months
Bill Jones wrote:My conclusion is that DCA for 6 to 12 months is the most that one should use, and then only if moving more than 5% of your total assets (since even the worst case would cut your overall total returns by only 1% or so). If you are shifting 30% or more of your total assets from cash to stock, you could take up to but no more than 18 months; this once-in-a-lifetime sort of situation merits overly-excessive caution. But I provide the data below on which you can base your own opinion.
Is the purchase of insurance "illogical" because it comes at a cost?


Also high on Dr. Bernstein's "must-read" list for asset allocators is Michael Edleson's Value Averaging: The Safe and Easy Strategy for Higher Investment Returns.

[quote="Micheal Edleson, in "Value Averaging,""]According to John Markese, Ph.D., director of research for the American Association of Individual Investors, "Dollar cost averaging gives you time diversification." This time diversification is different from that seen in Chapter 1. There, we saw that longer investment periods reduced the average annual volatility of the compound annual return -- very few long-term investment periods saw a loss. Spreading out your actual purchases over time is a different sort of risk-reducing diversification. When money is invested regularly, the average cost of shares is leveled out over time -- over good and bad prices. There is little of the risk, associated with lump-sum purchases, of buying into the market with your total investment right at the market peak. If you dollar cost average over long periods of time, you can take advantage of both forms of time diversification to reduce your investment risk.
[Emphasis added.][/quote]
It seems more straightforward to me to think of the diversification DCA produces as "purchase price diversification" rather than "time diversification," but the meaning as described above by Edleson is the same.

--Pete
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by bob90245 »

petrico wrote:From William Bernstein's Efficient Frontier site, we have this:

"Editors Note: Bill Jones is a math professor and frequent contributor to the Mutual Fund Interactive main board. I've seen many analyses of dollar cost averaging versus lump sum investing, but Bill's presentation of the conundrum as an insurance problem was both novel and elegant. With his kind permission EF reproduces it below."

Do Not Dollar-Cost-Average for More than Twelve Months
I didn't read the whole article, but jumped to the conclusion:
William Bernstein wrote:The payoff is higher for a 12-month period of DCA. Lump-summing lost money in 114 12-month periods, and DCA-12 beat lump-summing in 100 of them ...
Boy am I glad we decided not to ban discussion of Lump Sum vs DCA! :wink:
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Post by Dandy »

boy, people really have entrenched positions. I think we agree on some points:
1. Lump sum will give better returns most of the time
2. DCA will reduce risk most of the time
3. Adjusting your portfolio allocation can reduce risk

A person who chooses to DCA is choosing to reduce risk (and give up potential return) by adjusting his portfolio allocation i.e. temprarily holding more cash (a safe/low return vehicle). This, as opposed to reducing risk by temorarily changing his portfolio by doing a major re alignment of his existing holdings. Many will claim this is market timeing. To me it is agnostic. It is saying I don't know whether the market is high or low I just want to reduce risk by not going in all at once.

If the DCA is over a reasonably short period I think is should be characterized as a cautious, conservative, prudent approach by those who understand the trade offs. I agree that it is often used by people because of fear and mistunderstanding -- and for them it is a wise approach to offset fear and paralysis and at least get them investing.
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Post by LH »

When Dollar-Cost Averaging Makes Sense

http://moneywatch.bnet.com/investing/bl ... ense/1685/
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Post by baw703916 »

In thinking about DCA a little, I realized you can get a rough idea of the effect of DCA implemented over a period of several months by comparing an Index's or an ETF's 200 day SMA (simple moving average) to its price 200 days earlier.

The SMA value represents what you would have spent if you had spread out time purchases over the time period (although realistically, one wouldn't invest 0.5% of the total for 200 consecutive days).

What does this show? Usually, the SMA-200 will be higher than the price than the price 200 days earlier--but not if there happens to be a substantial drop in those 200 days. Furthermore, the SMA is a much smoother curve--there's less chance of happening to buy on the wrong day (at the peak of a short-term fluctuation).
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by LadyGeek »

umfundi wrote:My bitch & moan: Why is it that every discussion in this forum devolves into a belief about market timing, although we all supposedly agree that market timing does not work?

Dollar cost averaging is not a strategy. It is, simply, a consequence of systematic investing. Your average cost is less than the average price.

The complification of this fact is a disservice to less experienced investors. And, the recommended Bogleheads Wiki is, in this regard, wrong. Keith
The wiki maintains a neutral point of view, which addresses both positive and negative opinions fairly. Is there anything incorrectly stated that you would like changed? Your comments are welcome, but they must adhere to wiki policy and have forum consensus.
petrico wrote:Also high on Dr. Bernstein's "must-read" list for asset allocators is Michael Edleson's Value Averaging: The Safe and Easy Strategy for Higher Investment Returns.

[quote="Micheal Edleson, in "Value Averaging,""]According to John Markese, Ph.D., director of research for the American Association of Individual Investors, "Dollar cost averaging gives you time diversification." This time diversification is different from that seen in Chapter 1. There, we saw that longer investment periods reduced the average annual volatility of the compound annual return -- very few long-term investment periods saw a loss. Spreading out your actual purchases over time is a different sort of risk-reducing diversification. When money is invested regularly, the average cost of shares is leveled out over time -- over good and bad prices. There is little of the risk, associated with lump-sum purchases, of buying into the market with your total investment right at the market peak. If you dollar cost average over long periods of time, you can take advantage of both forms of time diversification to reduce your investment risk.
[Emphasis added.]
It seems more straightforward to me to think of the diversification DCA produces as "purchase price diversification" rather than "time diversification," but the meaning as described above by Edleson is the same.
--Pete[/quote]
Please take another look at "Value averaging" in the wiki. What's downplayed in most articles is the risk to investors in a down market- you may need to supply additional funds that may not be available, a very important point. This is not for beginners.

Wiki article link: Dollar cost averaging

The "Discussion" tab (top left corner) will show you the wiki editor collaboration for this section. References are listed under "External links."
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Post by zeugmite »

stives wrote:I think the people who need to DCA are the ones who have failed to set a proper asset allocation. Why compensate for risk twice unless you failed to compensate for it correctly the first time around? If you don't feel comfortable lump summing what you have into the market, then you are obviously at an asset allocation that is too aggressive for you.
A more aggressive asset allocation actually gives you greater expected return for the extra risk. Lump-sum gives you no greater expected return over DCA for the extra risk (except the time out of market issue -- let's ignore that for now...). If you had to choose where to put risk, you'd put it in the asset allocation part under these circumstances.
Last edited by zeugmite on Sat Oct 08, 2011 10:44 am, edited 1 time in total.
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by iceport »

LadyGeek wrote:
petrico wrote:Also high on Dr. Bernstein's "must-read" list for asset allocators is Michael Edleson's Value Averaging: The Safe and Easy Strategy for Higher Investment Returns.

[quote="Micheal Edleson, in "Value Averaging,""]According to John Markese, Ph.D., director of research for the American Association of Individual Investors, "Dollar cost averaging gives you time diversification." This time diversification is different from that seen in Chapter 1. There, we saw that longer investment periods reduced the average annual volatility of the compound annual return -- very few long-term investment periods saw a loss. Spreading out your actual purchases over time is a different sort of risk-reducing diversification. When money is invested regularly, the average cost of shares is leveled out over time -- over good and bad prices. There is little of the risk, associated with lump-sum purchases, of buying into the market with your total investment right at the market peak. If you dollar cost average over long periods of time, you can take advantage of both forms of time diversification to reduce your investment risk.
[Emphasis added.]
It seems more straightforward to me to think of the diversification DCA produces as "purchase price diversification" rather than "time diversification," but the meaning as described above by Edleson is the same.
--Pete
Please take another look at "Value averaging" in the wiki. What's downplayed in most articles is the risk to investors in a down market- you may need to supply additional funds that may not be available, a very important point. This is not for beginners.

Wiki article link: Dollar cost averaging[/quote]
Hi LadyGeek,

The quote from Edleson's book pertained solely to Dollar Cost Averaging. There was no intent to shift the discussion to value averaging, or advocate it. It's just the title of the book.

Also, I'm not umfundi, but I do believe the wiki overemphasizes the psychological aspect of DCA. IMHO, the Bill Jones piece published on the Efficient Frontier site is the most objective, most usefully framed analysis of DCA. In it, Jones clearly acknowledges the emotional benefit, but he also attempts to quantify the risk reduction.

Depending on your psychology, the expected drag on performance might outweigh the potential benefit of the risk reduction. Bill Jones offers some useful data with which to make an informed decision. But is that really any different a trade-off than your basic AA decision? Bogleheads don't generally imply the selection of a conservative AA is a crutch only required by those with a weak constitution. Yet the wiki does seem to imply as much of the use of DCA.

That might be the Boglehead consensus, but it does not seem neutral.

FWIW,
--Pete
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Post by umfundi »

The wiki maintains a neutral point of view, which addresses both positive and negative opinions fairly. Is there anything incorrectly stated that you would like changed? Your comments are welcome, but they must adhere to wiki policy and have forum consensus.
Maybe it's semantics, but I think DCA is a simple fact. If you periodically invest a constant dollar amount in an asset whose price varies, your average cost will be less than the asset's average price. Note that this is true whether the price trend is up, down, or sideways.

DCA is simply a result of periodic or systematic investing, which is a very smart thing to do. But, in the third sentence of the Wiki, the whole issue is muddied:
Dollar cost averaging is considered an alternative to investing a lump sum
Buried later in the entry is the real pearl:
periodic investing is maximizing expected return, because you are investing the money as soon as you have it.
Exactly. This should be the thrust of the article.

The Wikipedia entry on the subject is much better:
http://en.wikipedia.org/wiki/Dollar_cost_averaging

Here's my beef: Trickle investing a lump sum is market timing. Calling it DCA is yet another attempt to put lipstick on the pig and disguise it as something more respectable. (I fully acknowledge that you can come up with reasons to trickle invest a lump sum, but please don't call it DCA.)

Systematic investing should be the cornerstone of everyone's savings plan. Why discuss it in a way that casts doubt on it?

Keith :x
Last edited by umfundi on Sat Oct 08, 2011 11:44 am, edited 1 time in total.
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Post by kirent »

zeugmite wrote:
stives wrote:I think the people who need to DCA are the ones who have failed to set a proper asset allocation. Why compensate for risk twice unless you failed to compensate for it correctly the first time around? If you don't feel comfortable lump summing what you have into the market, then you are obviously at an asset allocation that is too aggressive for you.
A more aggressive asset allocation actually gives you greater expected return for the extra risk. Lump-sum gives you no greater expected return over DCA for the extra risk (except the time out of market issue -- let's ignore that for now...). If you had to choose where to put risk, you'd put it in the asset allocation part under these circumstances.
I'm not sure we're on the same page, but the out of market issue is precisely why DCA is an inferior approach. I am saying that if you feel you can't lump sum into your current asset allocation, then your current asset allocation is too risky for you. You should mitigate risk by holding more bonds in you AA, not holding cash to dynamically change your AA every time it's DCA time. Just because DCA has allowed you to stay at a more risky AA than you should be at doesn't mean that AA was right for you, and that correction will have to occur at a market downturn, the worst time. If no correction was needed than there should be no problem lump summing.
Last edited by kirent on Sat Oct 08, 2011 11:42 am, edited 1 time in total.
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baw703916
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Post by baw703916 »

stives wrote:
zeugmite wrote:
stives wrote:I think the people who need to DCA are the ones who have failed to set a proper asset allocation. Why compensate for risk twice unless you failed to compensate for it correctly the first time around? If you don't feel comfortable lump summing what you have into the market, then you are obviously at an asset allocation that is too aggressive for you.
A more aggressive asset allocation actually gives you greater expected return for the extra risk. Lump-sum gives you no greater expected return over DCA for the extra risk (except the time out of market issue -- let's ignore that for now...). If you had to choose where to put risk, you'd put it in the asset allocation part under these circumstances.
I'm not sure we're on the same page, but the out of market issue is precisely why DCA is an inferior approach. I am saying that if you feel you can't lump sum into your current asset allocation, then your current asset allocation is too risky for you. You should mitigate risk by holding more bonds in you AA, not holding cash to dynamically change your AA every time it's DCA time.
I tend to disagree, at least under some circumstances.

I just bumped, on the Personal Investments page,this thread that I started in 2008, when I received an inheritance smack in the middle of the financial panic. Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA? (ultimately, I invested the money over a few months time, and allocated some of it to municipal bonds, which also had depressed prices).

Brad
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kirent
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Post by kirent »

baw703916 wrote:
stives wrote:
zeugmite wrote:
stives wrote:I think the people who need to DCA are the ones who have failed to set a proper asset allocation. Why compensate for risk twice unless you failed to compensate for it correctly the first time around? If you don't feel comfortable lump summing what you have into the market, then you are obviously at an asset allocation that is too aggressive for you.
A more aggressive asset allocation actually gives you greater expected return for the extra risk. Lump-sum gives you no greater expected return over DCA for the extra risk (except the time out of market issue -- let's ignore that for now...). If you had to choose where to put risk, you'd put it in the asset allocation part under these circumstances.
I'm not sure we're on the same page, but the out of market issue is precisely why DCA is an inferior approach. I am saying that if you feel you can't lump sum into your current asset allocation, then your current asset allocation is too risky for you. You should mitigate risk by holding more bonds in you AA, not holding cash to dynamically change your AA every time it's DCA time.
I tend to disagree, at least under some circumstances.

I just bumped, on the Personal Investments page,this thread that I started in 2008, when I received an inheritance smack in the middle of the financial panic. Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA? (ultimately, I invested the money over a few months time, and allocated some of it to municipal bonds, which also had depressed prices).

Brad
I would say yes. Let's say you put it in to a proper allocation at that time. If the market continued to sank, you would be able to continue rebalancing from bonds to stock (giving a market adjusted like DCA effect). Being too afraid to put money in has the same effect of someone switching to a pure cash portfolio at the bottom and being too afraid to put the money back in when the markets were down.

That being said, since you felt an obligation to keep that money at low risk for as long as possible because the money was given to you, then DCA allowed you to meet that unusual demand.
Last edited by kirent on Sat Oct 08, 2011 12:11 pm, edited 1 time in total.
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allsop
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Post by allsop »

baw703916 wrote:[snip]
I just bumped, on the Personal Investments page,this thread that I started in 2008, when I received an inheritance smack in the middle of the financial panic. Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA? (ultimately, I invested the money over a few months time, and allocated some of it to municipal bonds, which also had depressed prices).

Brad
More than a few Bogleheads where very scared at that time period and reevaluated the basis of their investment strategies.

My more cynical response is that your calm and and reasonable thread lost the competition to the "OMG the world is ending" threads.
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tadamsmar
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by tadamsmar »

petrico wrote:From William Bernstein's Efficient Frontier site, we have this:

"Editors Note: Bill Jones is a math professor and frequent contributor to the Mutual Fund Interactive main board. I've seen many analyses of dollar cost averaging versus lump sum investing, but Bill's presentation of the conundrum as an insurance problem was both novel and elegant. With his kind permission EF reproduces it below."

Do Not Dollar-Cost-Average for More than Twelve Months
Bill Jones wrote:My conclusion is that DCA for 6 to 12 months is the most that one should use, and then only if moving more than 5% of your total assets (since even the worst case would cut your overall total returns by only 1% or so). If you are shifting 30% or more of your total assets from cash to stock, you could take up to but no more than 18 months; this once-in-a-lifetime sort of situation merits overly-excessive caution. But I provide the data below on which you can base your own opinion.
Is the purchase of insurance "illogical" because it comes at a cost?
Insurance is logical because the expected value of the utility function is in it's favor in spite of the fact that the expected value in dollars is not.

I am not sure that's true in this case.

Also, Jones' premise is that you, a long term investor, are insuring against a dip. Dips are not a threat to the long term investor. There is no need to insure against non-threats. A more conservative allocation or annuities, for instance, actually can mitigate real threats, so they are more like an insurance policy that you might want to "purchase" for the price of slower expected growth or elimination of inheritance.

Insurance is a good idea, but you need to be able to sort out the real threats from all the stuff that might scare you.
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Post by umfundi »

Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA?
No, but I will observe that it seems you were not willing to invest until after prices had gone up. :?

Keith
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allsop
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Post by allsop »

umfundi wrote:
Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA?
No, but I will observe that it seems you were not willing to invest until after prices had gone up. :?

Keith
So? He made a thread a couple of years ago with no answering posts with respect to DCA writing that none replied.
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Post by beyou »

If you believe in Asset Allocation, and select a target allocation,
why wait to invest to your target now ?

Maybe periodic investing into a desired AA (Target fund and/or
to multiple funds directly) makes sense as a "savings" plan to get you to
set aside money regularly for long term investing, but not DCA into
a stock or stock fund. Either it's the right strategy or it's not.
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baw703916
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Post by baw703916 »

umfundi wrote:
Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA?
No, but I will observe that it seems you were not willing to invest until after prices had gone up. :?

Keith
Not true. I had invested all of it well before March 2009. In fact, in March 2009 I started an SEP IRA and split it 50/50 between RZV and DGS.
Most of my posts assume no behavioral errors.
umfundi
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Post by umfundi »

baw703916 wrote:
umfundi wrote:
Are you really prepared to argue that if I wasn't willing to put in three years worth of my normal investments in a lump sum right in the middle of the Lehman-Merrill Lynch-AIG-TARP saga that I must have had the wrong AA?
No, but I will observe that it seems you were not willing to invest until after prices had gone up. :?

Keith
Not true. I had invested all of it well before March 2009. In fact, in March 2009 I started an SEP IRA and split it 50/50 between RZV and DGS.
Good! I think it is important to note that the fact of a cash windfall (lottery, inheritance) not only changes your actual asset allocation (AA), it may change your AA goal. If I were to inherit $2M I would become very conservative in my AA, because I would then have more than enough.

So, reevaluate your goal, and decide how to get there. Tomorrow, or in three months, or in six months?

I believe the answer is tomorrow, but if you are comfortable with a longer time frame, I don't think much harm will be done.

Keith
Déjà Vu is not a prediction
umfundi
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Re: Finally! Can we lay DCA to rest and ban this topic fore

Post by umfundi »

LadyGeek wrote:
Fallible wrote:The Wiki has an excellent article updated and expanded this summer to pull together just about all the pros ad cons of DCAing.
Wiki article link: Dollar cost averaging

It also includes "Reverse dollar cost averaging" which is a periodic distribution. Would the same opinions apply during a withdrawal phase?
Lady, Fallible,

"Reverse dollar cost averaging" means nothing.

"Strategies for systematic withdrawals" means something. Why not do what the government says? Withdraw 1/(life expectancy) each year.

Keith
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zeugmite
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Post by zeugmite »

bertilak wrote:Now consider two cases: 1) you receive the windfall as cash, and 2) you receive the windfall as securities already matching your AA. Case 1 is the case where the wisdom of DCA vs LS is at question.[/list]
Questions:
  • In case 2 would you liquidate the funds and DCA them back into the AA over time?

    If not, why would you DCA in case 1?

    If so, would you do the same with the funds you already had prior to the windfall? If not, why not?
Interesting thought experiment. With case 2, you're essentially trying to construct an an arbitrage argument against DCA. This is all very tricky and time out of the market probably has something to do with it. For one, if there is something to be gained from case 2, you still can't scale it up in the frequency at which you do it, because time out of the market would start to dominate. But once? I don't know.

On this note, consider also case 3: instead of receiving your amount as a basket of assets in the desired AA as in case 2, you receive the basket at a conversion rate that is based on the average of prices around the date. Would you pick case 3 over case 2?

Case 3 is constructed deliberately to sidestep the issues of time out of the market and different investment periods of LS vs. DCA.
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Post by Harold »

zeugmite wrote:
bertilak wrote:Now consider two cases: 1) you receive the windfall as cash, and 2) you receive the windfall as securities already matching your AA. Case 1 is the case where the wisdom of DCA vs LS is at question.[/list]
Questions:
  • In case 2 would you liquidate the funds and DCA them back into the AA over time?

    If not, why would you DCA in case 1?

    If so, would you do the same with the funds you already had prior to the windfall? If not, why not?
Interesting thought experiment. With case 2, you're essentially trying to construct an an arbitrage argument against DCA. This is all very tricky and time out of the market probably has something to do with it. For one, if there is something to be gained from case 2, you still can't scale it up in the frequency at which you do it, because time out of the market would start to dominate. But once? I don't know.

On this note, consider also case 3: instead of receiving your amount as a basket of assets in the desired AA as in case 2, you receive the basket at a conversion rate that is based on the average of prices around the date. Would you pick case 3 over case 2?

Case 3 is constructed deliberately to sidestep the issues of time out of the market and different investment periods of LS vs. DCA.
Haven't read this whole thread. But surely bertilak's point is that one can always use cash to buy securities, or sell securities for cash -- at current prices (time out of market is irrelevant).

Financially it makes no difference to one's approach whether cash or securities is the starting point -- can always buy/sell to get to the desired starting point. That it does make a difference for most people is an illustration of the psychological nature of this question.

There's nothing financially tricky about it.
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Post by zeugmite »

stives wrote:I would say yes. Let's say you put it in to a proper allocation at that time. If the market continued to sank, you would be able to continue rebalancing from bonds to stock (giving a market adjusted like DCA effect). Being too afraid to put money in has the same effect of someone switching to a pure cash portfolio at the bottom and being too afraid to put the money back in when the markets were down.

That being said, since you felt an obligation to keep that money at low risk for as long as possible because the money was given to you, then DCA allowed you to meet that unusual demand.
stives: I see what you are getting at. In a sense, I'm sympathetic to the argument that if you look at cash as part of the AA, then when you receive a windfall, the effect is merely that your AA deviated from what it should be and therefore you should correct it immediately. I think this is mostly right. This view would have nothing to recommend for DCA. Moreover, bertilak's last post gave an arbitrage argument that says pretty much the same thing. Furthermore, you've explained the no-arbitrage by linking the expected return for the days out of market to precisely the reduced risk. I have reservations about this last point -- there are some subtle issues regarding time horizon and whether the total invested time period is still assumed to be the same or not, but this is plausible.

Having said this, I again point to the link between volatility and the desire to DCA. Before dismissing this as irrational, consider that volatility (1) is not evenly distributed in time and (2) it has significant day-to-day correlation, unlike price returns. It may very well be that people would like to change AA based on volatility, but is prevented from doing so practically -- too much hassle, or if they do it, it is done non-systematically and with adverse selection. Presented with a new amount to invest during a period of high volatility, however, DCA can be interpreted as a heuristic to maintain a sort of risk balance. The windfall presumably comes at a random time.
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Post by zeugmite »

Harold wrote:
zeugmite wrote:
bertilak wrote:Now consider two cases: 1) you receive the windfall as cash, and 2) you receive the windfall as securities already matching your AA. Case 1 is the case where the wisdom of DCA vs LS is at question.[/list]
Questions:
  • In case 2 would you liquidate the funds and DCA them back into the AA over time?

    If not, why would you DCA in case 1?

    If so, would you do the same with the funds you already had prior to the windfall? If not, why not?
Interesting thought experiment. With case 2, you're essentially trying to construct an an arbitrage argument against DCA. This is all very tricky and time out of the market probably has something to do with it. For one, if there is something to be gained from case 2, you still can't scale it up in the frequency at which you do it, because time out of the market would start to dominate. But once? I don't know.

On this note, consider also case 3: instead of receiving your amount as a basket of assets in the desired AA as in case 2, you receive the basket at a conversion rate that is based on the average of prices around the date. Would you pick case 3 over case 2?

Case 3 is constructed deliberately to sidestep the issues of time out of the market and different investment periods of LS vs. DCA.
Haven't read this whole thread. But surely bertilak's point is that one can always use cash to buy securities, or sell securities for cash -- at current prices (time out of market is irrelevant).

Financially it makes no difference to one's approach whether cash or securities is the starting point -- can always buy/sell to get to the desired starting point. That it does make a difference for most people is an illustration of the psychological nature of this question.

There's nothing financially tricky about it.
I'm not discounting the psychological nature inherent in the question. In fact, I'm trying to figure out what the psychology implies about the actual desired allocation. To be clear, I am asking why shouldn't the AA of prior funds change, rather than why should new funds be DCA'ed in. The latter question isn't difficult to answer: it reduces risk.
Last edited by zeugmite on Sat Oct 08, 2011 4:17 pm, edited 1 time in total.
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Post by bertilak »

Harold wrote: Haven't read this whole thread. But surely bertilak's point is that one can always use cash to buy securities, or sell securities for cash -- at current prices (time out of market is irrelevant).

Financially it makes no difference to one's approach whether cash or securities is the starting point -- can always buy/sell to get to the desired starting point. That it does make a difference for most people is an illustration of the psychological nature of this question.

There's nothing financially tricky about it.
Yeah, that's the point, but I'm still somewhat swayed by arguments that the risk mitigated by DCA is somehow different from that mitigated by asset class diversification. But, the thought experiment makes it hard to see how. I am now leaning towards LS and as a prior DCA advocate might have to fall on my DCA sword!

But I don't see the pro-DCA case being simply a psychological case. DCA truly does provide diversification, called time diversification and entry price diversification above.

DCA may be based on a MISTAKEN argument that it is the most effective way to address certain risks, but it is not (at least in my case) a fear-driven argument any more than asset class diversification is fear-driven. It is RISK driven, which is a fundamental investment concern. Risk management, even if pursued ineffectively, is NOT simply something for weak-willed, wishy-washy, emotional cripples -- a point of view cited by more than one anti-DCA argument. That is simply name calling and is not persuasive.

DCA is ALSO not wrong simply because it lowers the expected return -- I wish I knew of a risk management technique that did not make that trade-off. Making this argument against DCA is also not persuasive.

Those who believe DCA is ineffective but then go on to say "go ahead, use DCA if it makes you feel better" are being disrespectful to investors trying to learn. People ARE smart enough to learn things. Give them a chance.
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Post by bob90245 »

umfundi wrote:Here's my beef: Trickle investing a lump sum is market timing. Calling it DCA is yet another attempt to put lipstick on the pig and disguise it as something more respectable. (I fully acknowledge that you can come up with reasons to trickle invest a lump sum, but please don't call it DCA.)
I understand; that is only your opinion.
umfundi wrote:Systematic investing should be the cornerstone of everyone's savings plan. Why discuss it in a way that casts doubt on it?
Those words don't appear consistent. My opinion is that we should not cast doubt on whether one should lump sum or DCA that lump sum. And certainly, equating DCA'ing a lump sum with market timing -- a no-no here according to the Boglehead approach -- casts doubt. Exactly the thing you and I agree should be avoided.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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risk

Post by hollowcave2 »

In the OP, DCA is claimed to be an "inferior" approach. What is this assumption or conclusion based upon?

If it's based on total return comparisons, then it's flawed from the beginning. The total returns, by themselves, are irrelevant.

DCA does not address potential returns at all. It is a risk management technique , not a technique to maximize returns. So any study that assesses DCA based on potential returns is inherently flawed. At the very least, risk adjusted total returns need to be assessed.

So DCA is not a dead issue. I still think it is a good way to get started investing, even if it is a psychological technique. The markets are driven by psychology, so this method certainly is a valid technique.

For those who like lump sum, go ahead. Let's see how your stomach takes it. It's a good test for assessing your risk tolerance.

And like I've always said, Lump sum works best with Other People's Money.

BTW, there is a mathematical certainty with the DCA approach that is not insignificant. With DCA, you are absolutely guaranteed to have your personal cost/share be equal to or lower than the average price of the security you are buying during the timeframe of DCA. So that's a nice little caveat, regardless of returns.

Still a fan of DCA,

Steve
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Post by mrwalken »

I've never understood why these debates center on dollar cost averaging, rather than value averaging. DCA offers no significant advantages in terms of returns or risk as compared to lump sum investing. The only reduction in risk you get is from the time you spend with less $$ invested under DCA than lump sum (and of course, there is a corresponding loss of expected return). Maybe there is some psychological advantage to slowly increasing your risk through DCA, but it still is going to suck just as much if the market crashes right after you have completed your DCA.

On the other hand, value averaging into the market has been shown to consistently beat lump sum investing. See "A Statistical Comparison of Value Averaging vs. Dollar Cost Averaging and Random Investment Techniques" by Marshall (available online). I've never heard a good explanation for this, as it seems to refute the EMH.
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Post by umfundi »

mrwalken wrote:I've never understood why these debates center on dollar cost averaging, rather than value averaging. DCA offers no significant advantages in terms of returns or risk as compared to lump sum investing. The only reduction in risk you get is from the time you spend with less $$ invested under DCA than lump sum (and of course, there is a corresponding loss of expected return). Maybe there is some psychological advantage to slowly increasing your risk through DCA, but it still is going to suck just as much if the market crashes right after you have completed your DCA.

On the other hand, value averaging into the market has been shown to consistently beat lump sum investing. See "A Statistical Comparison of Value Averaging vs. Dollar Cost Averaging and Random Investment Techniques" by Marshall (available online). I've never heard a good explanation for this, as it seems to refute the EMH.
Easy for you to say!

Value averaging requires a variable investment and a lot of fortitude.

A systematic constant dollar amount is much easier, psychologically.

Keith
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mrwalken
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Post by mrwalken »

umfundi wrote:Easy for you to say!

Value averaging requires a variable investment and a lot of fortitude.

A systematic constant dollar amount is much easier, psychologically.

Keith
I've read that, although I don't really understand it. So you buy more after a period of poor market performance (and therefore cheaper prices) and you buy less after a period of strong market performance (and therefore higher prices). Why is that hard? That's what everybody says you are supposed to do -- buy low and sell high. The effect is similar to rebalancing. If the strong EMH holds, neither value averaging nor rebalancing should improve returns. Yet they do.
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umfundi

Post by SlammingAces »

I don't see why Value Averaging is any harder to do than DCA psychologically. The math is slightly harder.

I think the answer to the OP's position is NO. This thread now has almost 150 replies and I think the debate goes on.
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umfundi
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Post by umfundi »

mrwalken wrote:
umfundi wrote:Easy for you to say!

Value averaging requires a variable investment and a lot of fortitude.

A systematic constant dollar amount is much easier, psychologically.

Keith
I've read that, although I don't really understand it. So you buy more after a period of poor market performance (and therefore cheaper prices) and you buy less after a period of strong market performance (and therefore higher prices). Why is that hard? That's what everybody says you are supposed to do -- buy low and sell high. The effect is similar to rebalancing. If the strong EMH holds, neither value averaging nor rebalancing should improve returns. Yet they do.
Ric Edelman (The Truth About Money, 1988) says (p. 278):
Value Averaging: This is actually a more effective strategy than dollar cost averaging, at least on paper, but I don't emphasize value averaging because most people cannot stick with it.
It is relatively easy to put your strategy on autopilot (systematic investing, periodic re-balancing). It is really hard to do that (actively manage it) day-to-day.

Suppose the market is down 40%. It's very hard to see that as an opportunity.

To paraphrase Andrew Tobias and Ric Edelman: If tuna goes on sale, we'll buy it by the case. If stocks go on sale, we'll dump what we have.

It's tough.

Keith
Last edited by umfundi on Sat Oct 08, 2011 7:16 pm, edited 1 time in total.
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