The Other Side, part 2

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sawhorse
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The Other Side, part 2

Post by sawhorse » Mon Jun 22, 2015 2:46 pm

TOPIC 2: LUMP SUM VS. DOLLAR COST AVERAGING

Please see this post for an overview of this series, methodology, and indexes used.

The first thread in this series demonstrated that for a Japanese investor in 1990, the lowest returning asset class to this day has been stocks, by a wide margin.

I have seen multiple times on this board that when someone presents a situation of investing in the stock market right before a bubble burst (Great Depression, dot com, etc), another poster will point out that this only applies to people who lump summed at the worst possible moment. Those who periodically contributed over the subsequent years not only broke even over a 15-20 year period but came out ahead. This was even true for the Great Depression despite how long it took for the stock market to recover from its previous high.

I have also seen on this board multiple opinions on whether it is better to lump sum or dollar cost average. Indeed, that is a heavily debated topic not just on this board but in the investing world in general.

This thread explores the outcomes of lump sum vs. dollar cost averaging for Japanese investors in 1990 for stocks and bonds. In these calculations, dollar cost averaging refers to contributing an equal nominal amount, 1000000¥ for example, at the start of every year into the asset category.

Returns on the charts are (total value – total cumulative contributions) ÷ total cumulative contributions.

Question 1: Has a stock investor done better with lump sum or dollar cost averaging? Has a bond investor done better with lump sum or dollar cost averaging?

Image

Conclusion: Dollar cost averaging has been superior to lump sum for stocks, but lump sum has been superior to dollar cost averaging for bonds. And so the debate continues.

Question 2: Has a lump sum investor done better with stocks or bonds? Has a dollar cost averaging investor done better with stocks or bonds?

Image

Conclusion: Bonds have outperformed stocks for both lump sum and dollar cost averaging investors. The difference is huge for lump sum investors. The difference is much smaller for dollar cost averaging investors and may reverse itself in the near future.

Here are all four options together.

Image

Lump sum vs. dollar cost averaging is most often discussed in the context of stocks, so I’ll say something more about stocks. Proponents of dollar cost averaging cite decreased downside risk as a benefit. Risk is especially salient for stocks, and that is where dollar cost averaging has really benefitted the Japanese investor. A Japanese stock investor who lump summed 25 years ago is still down over 40% nominally. The stock investor who dollar cost averaged has done disappointingly, but at least they have enjoyed some years of positive returns. As of the start of 2015, they had almost caught up with a bond dollar cost averager.

Bond yields are very low these days, and the Japanese stock market has had two consecutive years of positive returns. If these trends continue the stock market dollar cost averager may come out ahead over a 30 year period (not including the money spent on antacids!).

If the stock market tanks again, however, then bond investors will clearly win over the 30 year period with piggy bank investors in second place. Yikes. Fingers crossed.

Even if the dollar cost averaging stock investors don’t come out ahead, there is no question that dollar cost averaging has been effective in reducing downside risk for a Japanese stock investor over the past 25 years.

Update:
I realized that I forgot to deduct expense ratios for some of the lines. Will fix this in next thread.
Last edited by sawhorse on Thu Jun 25, 2015 12:09 pm, edited 4 times in total.

Waba
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Re: The Other Side, part 2

Post by Waba » Mon Jun 22, 2015 9:04 pm

Can we do rebalancing next?

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Re: The Other Side, part 2

Post by EnjoyIt » Mon Jun 22, 2015 9:07 pm

or maybe see what a 50/50 portfolio would look like lump sum and DCA?

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Re: The Other Side, part 2

Post by ogd » Mon Jun 22, 2015 9:28 pm

sawhorse wrote:Even if the dollar cost averaging stock investors don’t come out ahead, there is no question that dollar cost averaging has been effective in reducing downside risk for a Japanese stock investor over the past 25 years.
It wasn't DCA. It was cash that reduced the risk.

The simple explanation to the Japanese DCA paradox is that stocks did worse than cash, and bonds did better, particularly in the early period. It's not some fundamental difference between bonds and stocks (in this respect -- there certainly is in others).

If one thinks that cash is likely to outperform stocks in the immediate future, one can certainly go ahead and DCA, although this does raise an obvious alternative.

Since I don't harbor such thoughts, I see no point in taking more risk as time goes by, particularly since Uncle Sam is less willing to share in my losses the more I depart from my cost basis. A slight reduction over time seems more reasonable even if one doesn't otherwise follow a "bond growth with age" trajectory.

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Re: The Other Side, part 2

Post by sawhorse » Mon Jun 22, 2015 9:53 pm

Waba wrote:Can we do rebalancing next?
Yes! In the next part I'll explore different asset allocations and glide paths with rebalancing. Later I'll look at whether it has been better to stay the course.
EnjoyIt wrote:or maybe see what a 50/50 portfolio would look like lump sum and DCA?
Here you go. This is with rebalancing at the time of each annual contribution. 50/50 DCA is actually a little ahead of Bonds DCA now. Four approaches (50/50 DCA, 50/50 lump, Bonds DCA, and Stocks DCA) are all about equal now. This was the case back in 2005 too, and then stocks went down.

Image

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Re: The Other Side, part 2

Post by EnjoyIt » Mon Jun 22, 2015 11:32 pm

https://www.statbureau.org/en/japan/inf ... mount=1000

according to the above link inflation in total never really hit Japan in 1990 an item purchased for 1000 yen would cost 1121 yen in 2015. Which means a 50/50 portfolio with DCA and yearly rebalancing was up ~44% over the 25 year time span in Real terms. Not great, but at least not as devastating as I thought it would be.

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Re: The Other Side, part 2

Post by sawhorse » Mon Jun 22, 2015 11:58 pm

EnjoyIt wrote:https://www.statbureau.org/en/japan/inf ... mount=1000

according to the above link inflation in total never really hit Japan in 1990 an item purchased for 1000 yen would cost 1121 yen in 2015. Which means a 50/50 portfolio with DCA and yearly rebalancing was up ~44% over the 25 year time span in Real terms. Not great, but at least not as devastating as I thought it would be.
Yes, inflation was very low and sometimes negative. That makes these losses more bearable. It still must feel pretty bad to save and invest every year for 25 years, rather than spending it on some splurge purchases, and only gain that much. I really hope there isn't a downturn over the next few years.

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Re: The Other Side, part 2

Post by JoMoney » Tue Jun 23, 2015 4:16 am

You should be able to look at a chart, and tell if the returns would have helped or hurt by "rebalancing" or DCA.
Choppy waves that go up and down and mean-revert look good for rebalancing/DCA.
Streaks of upward momentum with few (or relatively small) dips are best for 'buy and hold'/Lump Sum.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: The Other Side, part 2

Post by sawhorse » Tue Jun 23, 2015 8:40 am

JoMoney wrote:You should be able to look at a chart, and tell if the returns would have helped or hurt by "rebalancing" or DCA.
Choppy waves that go up and down and mean-revert look good for rebalancing/DCA.
Streaks of upward momentum with few (or relatively small) dips are best for 'buy and hold'/Lump Sum.
Yes, bonds were upward, so lump sum was better. Stocks were choppy, so DCA was better. The difficulty for an investor is that you can't predict in advance which will be better.

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Re: The Other Side, part 2

Post by Maynard F. Speer » Tue Jun 23, 2015 7:27 pm

Another thing perhaps to think about with Japan is that it's only coming out of its economic quagmire thanks to this unprecedented QE experiment, and interest rates being on the floor

Image

Were we to hit another Japan today, in almost any developed market, we would have already played the stimulus card, and any downturn could be much more painful and drawn out ... In the 19th century, bonds outperformed stocks for something in the region of 73 years

Of course bonds are in a very different position today too, with negative rates in parts of Europe, and very low returns predicted going forwards ... So I wouldn't look at Japan as a worst-case-scenario - I'd look at: what would the Japanese markets look like today if QE and lower rates weren't an option .. I'm fairly certain they'd still be falling - in terms of PE10 or Market/GDP, they could fall another 50% from here and still not be cheap
"Economics is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." - John Maynard Keynes

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Re: The Other Side, part 2

Post by backpacker » Tue Jun 23, 2015 8:25 pm

EnjoyIt wrote:https://www.statbureau.org/en/japan/inf ... mount=1000

according to the above link inflation in total never really hit Japan in 1990 an item purchased for 1000 yen would cost 1121 yen in 2015. Which means a 50/50 portfolio with DCA and yearly rebalancing was up ~44% over the 25 year time span in Real terms. Not great, but at least not as devastating as I thought it would be.
The worst case scenario for DCAing is the DCAer who starts in the mid 1980s (it might be interesting to have a chart starting in, say, 1985). DCAers who started at the top of the Japanese market had almost nothing in the market, so lost almost nothing when the market crashed. DCAers who started in the 70s or even early 80s participated in the run-up before the crash. They lost a lot of money, but it was mostly gains from the run-up.

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Re: The Other Side, part 2

Post by backpacker » Tue Jun 23, 2015 8:33 pm

sawhorse wrote:Inflation was very low and sometimes negative. That makes these losses more bearable. It still must feel pretty bad to save and invest every year for 25 years, rather than spending it on some splurge purchases, and only gain [44%].
It depends on what an investors goals were. For someone who has to save for retirement, 44% is less than they might want. But they have to save for retirement. Deferring consumption is not optional. Those investors should have no regrets.

Another point about deflation: Because the yen deflated against other currencies, a Japanese investor would have also gotten less than stellar returns from international investments. Local deflation is really bad because it not only hurts the local economy, but also foreign investments. Inflation means that at least foreign investments should have respectable returns.

On the other hand, the Japanese crash is not the sort of crash that could "just happen" at any time to any market. Valuations were insane, the likes of which had not been seen before and that we have not been seen since. The Tokyo stock exchange had an average price to book value of 5.5, more than double the price to book of the currently "fully valued" S&P 500.

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Re: The Other Side, part 2

Post by grabiner » Tue Jun 23, 2015 8:44 pm

The dollar-cost averaging you are considering is not the choice most investors make. If you earn money to invest every year, you will invest it every year; while this is dollar-cost averaging, it is not a choice. If you have a large sum of money now, you might lump-sum it, or invest 10% every month for ten months; you aren't going to invest 5% every year for 20 years.
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Re: The Other Side, part 2

Post by robert88 » Tue Jun 23, 2015 8:46 pm

Are you going to look at SWRs in Japan?

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Re: The Other Side, part 2

Post by sawhorse » Tue Jun 23, 2015 11:47 pm

grabiner wrote:The dollar-cost averaging you are considering is not the choice most investors make. If you earn money to invest every year, you will invest it every year; while this is dollar-cost averaging, it is not a choice. If you have a large sum of money now, you might lump-sum it, or invest 10% every month for ten months; you aren't going to invest 5% every year for 20 years.
Yes, I used dollar cost averaging in the regular periodic investment sense that most people use in their working years due to necessity. You're right that this doesn't apply to the lump sum vs dollar cost averaging debate in the context of a windfall.
robert88 wrote:Are you going to look at SWRs in Japan?
I wasn't planning to because I'm quite unfamiliar with how SWRs are calculated. But if you tell me how and give me the relevant information about Japanese programs analogous to Social Security, I'll try to do it. I am curious about the results because Japan has a very long life expectancy.
backpacker wrote:On the other hand, the Japanese crash is not the sort of crash that could "just happen" at any time to any market. Valuations were insane, the likes of which had not been seen before and that we have not been seen since. The Tokyo stock exchange had an average price to book value of 5.5, more than double the price to book of the currently "fully valued" S&P 500.
Yeah, it was like the bubble right before the 2000 crash. The S&P 500 had a price to book value of over 5.0 which was largely driven by the NASDAQ stocks in the index. NASDAQ had a price to book value of 6.7 in 1999. I think one reason the Japanese crash has been more difficult to recover from is that the high valuations were more widespread whereas, although the overall valuations were comparable preceding the 2000 US crash, they were more concentrated in certain types of companies and sectors. NASDAQ broke even nominally a few months ago. Still has to rise almost 40% to break even inflation adjusted.

Any idea what the price to book value was before the Great Depression?

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Re: The Other Side, part 2

Post by SimpleGift » Wed Jun 24, 2015 8:00 am

sawhorse wrote:
robert88 wrote:Are you going to look at SWRs in Japan?
I wasn't planning to because I'm quite unfamiliar with how SWRs are calculated. But if you tell me how and give me the relevant information about Japanese programs analogous to Social Security, I'll try to do it. I am curious about the results because Japan has a very long life expectancy.
In a couple of brief articles from 2011, Wade Pfau looked at historical SWRs in Japan:

20-Year Sustainable Withdrawal Rates for US and Japan
Japan 1990 — A Black Swan for Retirees? No.

Nothing like losing a world war, followed by hyperinflation, to ruin one's whole retirement plan! Japanese retirees in the 1930s-1940s would have wanted their bond allocation in TIPS (if only they were available).

Image
Note: This chart shows 20-year SWRs, not the normal 30-year SWR.
Source: Retirement Researcher
Cordially, Todd

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Re: The Other Side, part 2

Post by Maynard F. Speer » Wed Jun 24, 2015 9:48 am

sawhorse wrote:Any idea what the price to book value was before the Great Depression?
I'm not sure how long we've been measuring the market by book value - but there are arguments against its usefulness today, as it's generally come down across most markets (perhaps as technology's enabled us to build businesses with fewer staff and lower expenses)

CAPE just before the Great Depression peaked in the mid-30s .. Today we're possibly somewhere around 28

Image

The only solution I've found to this problem (and I did hundreds of spreadsheets looking at investing approaches) - and the solution large endowment funds tend to employ - is to invest significantly in more market-neutral alternatives, and minimise losses ... So something like 1/3rd stocks, 1/3rd cash/bonds, 1/3rd alternatives ... What the endowments do, with a generally conservative asset allocation, is up the risk in equities - so you could tilt towards Small-Cap Value, Microcaps and Emerging Markets .. If you had a small portfolio, P2P lending (targeting 10% returns) could be a great alternative investment - larger, and you'll probably have to look at absolute return funds
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Re: The Other Side, part 2

Post by robert88 » Wed Jun 24, 2015 5:51 pm

sawhorse wrote:
robert88 wrote:Are you going to look at SWRs in Japan?
I wasn't planning to because I'm quite unfamiliar with how SWRs are calculated. But if you tell me how and give me the relevant information about Japanese programs analogous to Social Security, I'll try to do it. I am curious about the results because Japan has a very long life expectancy.
Safe withdrawal rates represent the highest percentage of an initial portfolio balance that can be withdrawn every year over some time frame without going broke. For example, if your initial portfolio balance is $1 million, a 4% SWR means that you can withdraw $40k/year adjusted for inflation every year over some time period usually 30 years without going broke and that withdrawing more than $40k/year will cause you to go broke. It's similar to DCA in reverse. Sometimes, SWRs are specified assuming that the investor has perfect foresight to choose the best fixed AA for the year that he retires. I think they're more realistic and more useful assuming some reasonable AA(50/50) since the perfect AA for a given retirement year can only be known in hindsight.

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Re: The Other Side, part 2

Post by Rodc » Wed Jun 24, 2015 6:16 pm

How did you define dollar (or yen) cost averaging?

It seems to me to be fair, you have to start with some amount that is equal in both cases. Say $100,000 dollars. Say you want to look at 10 years so put in $10,000 per year into stocks vs all into stocks. But the balance has to be invested in something which has some earnings of its own.

Then to be apples to apples you have to somehow account for the fact that in one case you are 100% in stocks vs roughly 50% in stocks, and so one has far less risk than the other. One cannot, or should not, look at returns without looking at the risk taken. For example the lump sum might be 50% stocks and 50% bonds right off the bat vs 0%/100%% sliding to 100%/0%, so roughly equal in risk. In one case all the stocks are purchased in one fell swoop and in the other they are purchased slowly over time.

You might have covered this somewhere, but I am curious.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: The Other Side, part 2

Post by sawhorse » Wed Jun 24, 2015 6:45 pm

Rodc wrote:How did you define dollar (or yen) cost averaging?
Rodc, I defined dollar cost averaging in this case as periodically investing an equal amount at the beginning of every year (see first post). It doesn't assume that the person had money elsewhere. I was thinking more in terms of people over their working years, putting, say, $1000 of their previous year's salary into the stock market on the first of the year, and doing that every year.

I understand that this is only one definition of dollar cost averaging and perhaps doesn't address the decision that faces someone getting a windfall. I didn't think to do that because, like grabiner said, someone getting a windfall probably wouldn't decide to invest it over a 25 year period. If you want me to do that, I can try with the assumption that the non-invested money is sitting in cash. I can only do it on an annual basis because I only have annual data for cash. Given that the cash would be earning more than 0%, the advantage of dollar cost averaging over the 25 years would be greater for reasons explained by ogd.
grabiner wrote:If you have a large sum of money now, you might lump-sum it, or invest 10% every month for ten months
I ran the numbers on monthly investing over 10 months starting Jan 1990 vs. dumping it all in at once. I could only do this for stocks because I don't have monthly data for the other asset classes, and I used the MSCI Japan index with dividends reinvested since I don't have monthly data for TOPIX. The TOPIX should be basically the same since they cover the same range of stocks.

In this scenario, both would have the full amount invested in October 1990. At the end of October 1990, lump sum is down 37.4% and DCA is down 18.5%. Those two values carry forward the rest of the years, so lump sum will always been behind. I didn't deduct any expense ratios.

Of the 12 possible monthly starting points in 1990, dollar cost averaging over 10 months beat lump sum 9 of the 12 times by an average of 15.62%. Lump sum beat dollar cost averaging 3 of the 12 times by an average of 4.95%. Of the 24 possible monthly starting points between 1990 and 1991, dollar cost averaging over 10 months beat lump sum 20 of the 24 months.

For the dollar cost averaging calculations, I assumed that the non-invested money was earning 0% because I don't have monthly data for cash. Again, the advantage of dollar cost averaging would have been greater for the reasons explained by ogd.
robert88 wrote:
sawhorse wrote:
robert88 wrote:Are you going to look at SWRs in Japan?
I wasn't planning to because I'm quite unfamiliar with how SWRs are calculated. But if you tell me how and give me the relevant information about Japanese programs analogous to Social Security, I'll try to do it. I am curious about the results because Japan has a very long life expectancy.
Safe withdrawal rates represent the highest percentage of an initial portfolio balance that can be withdrawn every year over some time frame without going broke. For example, if your initial portfolio balance is $1 million, a 4% SWR means that you can withdraw $40k/year adjusted for inflation every year over some time period usually 30 years without going broke and that withdrawing more than $40k/year will cause you to go broke. It's similar to DCA in reverse. Sometimes, SWRs are specified assuming that the investor has perfect foresight to choose the best fixed AA for the year that he retires. I think they're more realistic and more useful assuming some reasonable AA(50/50) since the perfect AA for a given retirement year can only be known in hindsight.
Thanks for the explanation robert88. Since the life expectancy in Japan is high, how long would the retirement period be? I might not have data going back that far.

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Re: The Other Side, part 2

Post by robert88 » Wed Jun 24, 2015 10:05 pm

sawhorse wrote: Thanks for the explanation robert88. Since the life expectancy in Japan is high, how long would the retirement period be? I might not have data going back that far.
The length of the retirement period is somewhat arbitrary, but 30 years seems to be the de facto standard that everyone seems to go with. If you were actually a Japanese investor you might want to extend the period to account for a longer life expectancy, but for our purposes, sticking to 30 years should make the results more directly comparable to those you see based on US investment returns. For an investor retiring 12-31-1989, you only have 25.5 years of data, but you could extrapolate the last 4.5 years using an assumed 3% real return or whatever number you think is reasonable. Then come back in 2020 and update your post with actual data.

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Re: The Other Side, part 2

Post by sawhorse » Wed Jun 24, 2015 10:13 pm

robert88 wrote:
sawhorse wrote: Thanks for the explanation robert88. Since the life expectancy in Japan is high, how long would the retirement period be? I might not have data going back that far.
The length of the retirement period is somewhat arbitrary, but 30 years seems to be the de facto standard that everyone seems to go with. If you were actually a Japanese investor you might want to extend the period to account for a longer life expectancy, but for our purposes, sticking to 30 years should make the results more directly comparable to those you see based on US investment returns. For an investor retiring 12-31-1989, you only have 25.5 years of data, but you could extrapolate the last 4.5 years using an assumed 3% real return or whatever number you think is reasonable. Then come back in 2020 and update your post with actual data.
If you let me know what asset allocation to use, then I'll try to calculate some numbers. If there are enough "What would the results be if you had ___ " questions, maybe I'll do an extra thread at the end.
Last edited by sawhorse on Wed Jun 24, 2015 10:20 pm, edited 1 time in total.

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Re: The Other Side, part 2

Post by longinvest » Wed Jun 24, 2015 10:14 pm

sawhorse, you could put your Japan return data in the wiki:Variable percentage withdrawal spreadsheet. It has a Comparison sheet displaying and comparing VPW and SWR (called Constant-dollar withdrawal). All of the work would be done for you, once you enter the data (except if you want to polish the display with proper currency name, etc.).
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Re: The Other Side, part 2

Post by robert88 » Wed Jun 24, 2015 11:56 pm

sawhorse wrote:
robert88 wrote:
sawhorse wrote: Thanks for the explanation robert88. Since the life expectancy in Japan is high, how long would the retirement period be? I might not have data going back that far.
The length of the retirement period is somewhat arbitrary, but 30 years seems to be the de facto standard that everyone seems to go with. If you were actually a Japanese investor you might want to extend the period to account for a longer life expectancy, but for our purposes, sticking to 30 years should make the results more directly comparable to those you see based on US investment returns. For an investor retiring 12-31-1989, you only have 25.5 years of data, but you could extrapolate the last 4.5 years using an assumed 3% real return or whatever number you think is reasonable. Then come back in 2020 and update your post with actual data.
If you let me know what asset allocation to use, then I'll try to calculate some numbers. If there are enough "What would the results be if you had ___ " questions, maybe I'll do an extra thread at the end.
50/50

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Re: The Other Side, part 2

Post by assumer » Thu Jun 25, 2015 12:06 am

If you have the finances to either dca or lump sum at a specific date (1990), and you choose to lump sum you simply keep a 100% 0% cash allocation forever with that amount of cash. If you choose to dca you simple are doing your own glide path with cash vs stocks. You're doing nothing more complicated than the "age in bonds" standard advice. Except you're doing the opposite. You're increasing that stock allocation over time as you get older from maybe 20% stock 80% cash to 25% stock 75% cash the next year (because if you have the funds, and you choose to dca you're presumably keeping the remainder in cash).

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Re: The Other Side, part 2

Post by Rodc » Thu Jun 25, 2015 6:16 am

Rodc, I defined dollar cost averaging in this case as periodically investing an equal amount at the beginning of every year (see first post). It doesn't assume that the person had money elsewhere. I was thinking more in terms of people over their working years, putting, say, $1000 of their previous year's salary into the stock market on the first of the year, and doing that every year.

I understand that this is only one definition of dollar cost averaging and perhaps doesn't address the decision that faces someone getting a windfall. I didn't think to do that because, like grabiner said, someone getting a windfall probably wouldn't decide to invest it over a 25 year period. If you want me to do that, I can try with the assumption that the non-invested money is sitting in cash. I can only do it on an annual basis because I only have annual data for cash. Given that the cash would be earning more than 0%, the advantage of dollar cost averaging over the 25 years would be greater for reasons explained by ogd.
I appreciate you are working hard at understanding some of the basic issues underlying investing and that you are taking a good amount of time to write things up for the forum. Unfortunately given what you wrote above this is not a useful exercise. Someone putting in money regularly over their working years without a lump sum can never lump sum. So there is no point is comparing them to someone who can lump sum. So you have a totally non-actionable scenario. Plus you still have the apples to oranges risk problem to deal with.

The whole discussion around lump vs DCA is entirely different from the scenario you have constructed. This has no bearing on that discussion. I don't see how this is useful to an investor.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: The Other Side, part 2

Post by sawhorse » Thu Jun 25, 2015 11:48 am

Rodc wrote:The whole discussion around lump vs DCA is entirely different from the scenario you have constructed. This has no bearing on that discussion. I don't see how this is useful to an investor.
Rodc, did you see the calculations I ran in response to grabiner's post? If that doesn't satisfy your objections, then what would?

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Re: The Other Side, part 2

Post by backpacker » Thu Jun 25, 2015 1:46 pm

sawhorse wrote:
Rodc wrote:The whole discussion around lump vs DCA is entirely different from the scenario you have constructed. This has no bearing on that discussion. I don't see how this is useful to an investor.
Rodc, did you see the calculations I ran in response to grabiner's post? If that doesn't satisfy your objections, then what would?
What sawhorse is doing here is important. The reason is that for most of us, DCA returns represent how risky future market returns really are. But when people talk about market risk, they often talk about peak-to-trough losses. Peak-to-trough losses often give the impression that markets are riskier than they really are for DCA investors.

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Re: The Other Side, part 2

Post by longinvest » Thu Jun 25, 2015 2:04 pm

backpacker wrote:
sawhorse wrote:
Rodc wrote:The whole discussion around lump vs DCA is entirely different from the scenario you have constructed. This has no bearing on that discussion. I don't see how this is useful to an investor.
Rodc, did you see the calculations I ran in response to grabiner's post? If that doesn't satisfy your objections, then what would?
What sawhorse is doing here is important. The reason is that for most of us, DCA returns represent how risky future market returns really are. But when people talk about market risk, they often talk about peak-to-trough losses. Peak-to-trough losses often give the impression that markets are riskier than they really are for DCA investors.
While I agree that Sawhorse's intentions are quite interesting to many of us, I also have to agree with Rodc. He is right in saying that DCA (where a big pile of money is left in a bank account without interest and invested gradually over 25 years) is mostly useless to most of us.

What most of us do, in real life, is not "DCA"; it is "regular contributions". To evaluate the impact of market returns on regular contributions, one should compute the dollar-weighted return of the portfolio over the measured period. That's the really interesting number. (That's the investor return, or XIRR return, if you prefer those names).

Graphically, regular contributions should look like an increasing line, due to contributions. It would be very interesting to see 3 regular-contribution lines in a single graph: 100% bonds, 100% stocks, and 50/50.
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sawhorse
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Re: The Other Side, part 2

Post by sawhorse » Thu Jun 25, 2015 2:32 pm

Thanks for all the good feedback. I now realize that treating this as dollar cost averaging was misleading. The closest I can come to what I now understand is true dollar cost averaging is with the calculations I did in response to grabiner's post:
sawhorse wrote:
grabiner wrote:If you have a large sum of money now, you might lump-sum it, or invest 10% every month for ten months
I ran the numbers on monthly investing over 10 months starting Jan 1990 vs. dumping it all in at once. I could only do this for stocks because I don't have monthly data for the other asset classes, and I used the MSCI Japan index with dividends reinvested since I don't have monthly data for TOPIX. The TOPIX should be basically the same since they cover the same range of stocks.

In this scenario, both would have the full amount invested in October 1990. At the end of October 1990, lump sum is down 37.4% and DCA is down 18.5%. Those two values carry forward the rest of the years, so lump sum will always been behind. I didn't deduct any expense ratios.

Of the 12 possible monthly starting points in 1990, dollar cost averaging over 10 months beat lump sum 9 of the 12 times by an average of 15.62%. Lump sum beat dollar cost averaging 3 of the 12 times by an average of 4.95%. Of the 24 possible monthly starting points between 1990 and 1991, dollar cost averaging over 10 months beat lump sum 20 of the 24 months.

For the dollar cost averaging calculations, I assumed that the non-invested money was earning 0% because I don't have monthly data for cash. Again, the advantage of dollar cost averaging would have been greater for the reasons explained by ogd.
Am I correct in interpreting what I did as dollar cost averaging over a period of 25 years (and thus not really dollar cost averaging in the traditional sense since no one would spread it out that much), keeping the rest under the mattress?

EnjoyIt
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Re: The Other Side, part 2

Post by EnjoyIt » Thu Jun 25, 2015 4:29 pm

I think using the term DCA is probably not right, but the calculations are very interesting and very useful. This is what a Japanese investor might experience if they started contributing into retirement in 1990.

Thank you for taking the time to show it to us.

longinvest
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Re: The Other Side, part 2

Post by longinvest » Thu Jun 25, 2015 4:30 pm

sawhorse wrote:Thanks for all the good feedback. I now realize that treating this as dollar cost averaging was misleading. The closest I can come to what I now understand is true dollar cost averaging is with the calculations I did in response to grabiner's post:
[...]
Am I correct in interpreting what I did as dollar cost averaging over a period of 25 years (and thus not really dollar cost averaging in the traditional sense since no one would spread it out that much), keeping the rest under the mattress?
"Dollar cost averaging" is an ambiguous term in the financial press. It has a precise meaning for financial theorists, but the fact of the matter is that it has been largely abused in the financial press to mean two different things: a) investing a pile of money gradually over a period of time, and b) making regular investments of new money over time.

What we want is b), of course (which should NOT be called DCA).

Here's how I would go about computing it.

I would first compute the portfolio balance over time, for an annual $10K contribution made on January 1st:

Code: Select all

Year	100% stocks	100% bonds	50/50	stocks	bonds
1990	0,00 $	0,00 $	0,00 $	5.00%	2.00%
1991	10 500,00 $	10 200,00 $	10 350,00 $	5.01%	2.01%
1992	21 527,05 $	20 606,02 $	21 064,29 $	5.02%	2.02%
...
Then, I would chart the three balance columns over time.

I'll send you a private message with an example spreadsheet. You'll only have to fill in the returns for stocks and bonds. It computes the balance and a chart.
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sawhorse
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Re: The Other Side, part 2

Post by sawhorse » Thu Jun 25, 2015 5:17 pm

Thank you longinvest. I'm not sure how what I've charted for "dollar cost averaging" (quotes to signify that it's technically not the proper definition) is different qualitatively from what you describe. My graphs show returns as a function of contributions. It's like a chart of the values rotated around the total contributions as of that time period. So values above 0 mean that your portfolio is worth more than you've contributed and values below 0 mean that your portfolio is worth less than you've contributed.

longinvest
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Re: The Other Side, part 2

Post by longinvest » Thu Jun 25, 2015 6:03 pm

sawhorse wrote:Thank you longinvest. I'm not sure how what I've charted for "dollar cost averaging" (quotes to signify that it's technically not the proper definition) is different qualitatively from what you describe. My graphs show returns as a function of contributions. It's like a chart of the values rotated around the total contributions as of that time period. So values above 0 mean that your portfolio is worth more than you've contributed and values below 0 mean that your portfolio is worth less than you've contributed.
OK, I can see that your charts are probably correct, technically, as long as one reads through all of your messages to find the explanations required to correctly interpreted them. It's not until this last message that I think that I finally understood how you built them (and what they mean). Let's just say that your charts are not standard. (I don't want to get into arguments about the time value of money, making the comparison of "current portfolio balance" to "total amount contributed" less meaningful than one might think).

I am proposing to build new, simpler-to-interpret charts.

I like a chart to match what I would see in my account over time. For a one-time investment, this is usually a Growth of $ 10,000 chart. You'll note that this is a "portfolio balance" chart (where the initial balance is $ 10,000). That's the kind of charts we are used to see on this forum and on Morningstar. (For Japan, this should probably be a growth of 10,000 yens).

For a regular investment over a number of years, the equivalent would be the kind of chart I am proposing. A $ 10,000 contribution per year growth chart would allow me to see what my portfolio balance would have been over the period.

I really don't want to criticize your work; what you're doing is really great! I am just trying to help remove ambiguities in what you want to present us.

Thanks for your work and patience. :)
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sawhorse
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Re: The Other Side, part 2

Post by sawhorse » Fri Jun 26, 2015 1:01 am

longinvest wrote:
sawhorse wrote:Thank you longinvest. I'm not sure how what I've charted for "dollar cost averaging" (quotes to signify that it's technically not the proper definition) is different qualitatively from what you describe. My graphs show returns as a function of contributions. It's like a chart of the values rotated around the total contributions as of that time period. So values above 0 mean that your portfolio is worth more than you've contributed and values below 0 mean that your portfolio is worth less than you've contributed.
OK, I can see that your charts are probably correct, technically, as long as one reads through all of your messages to find the explanations required to correctly interpreted them. It's not until this last message that I think that I finally understood how you built them (and what they mean). Let's just say that your charts are not standard.
Thanks a lot for your feedback.

I might redo this thread using clearer terminology and charts within the limitations of the available data, my graphing abilities, and the time to rework what I've already done.

Is it worthwhile (i.e., interesting and/or informative to readers) for me to look at dollar cost averaging--not periodically investing income but dollar cost averaging--over X number of years? The assumption would be that the non-stock amount is in cash earning interest at the money market rate. (This would not be the case with periodically investing income because you wouldn't have the other money earning anything.) I would look at how much you'd have if you dollar cost averaged over 2 years, 5 years, 10 years, etc. As others have said, it's kind of unrealistic because someone in that situation wouldn't choose to dollar cost average over 25 years. On the other hand, it's kind of interesting that if someone did in fact do that, they'd be ahead of someone who lump summed because cash has outperformed stocks over the 25 year period. I was thinking of trying to find the "optimal" number of years to dollar cost average over.

In such a case, how do you treat the earnings on cash--do you keep them in cash and dump the same amount into the stock market the beginning of each year regardless of earnings on cash, or do you transfer the earnings on cash to the stuff that gets dumped into the stock market?

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Re: The Other Side, part 2

Post by longinvest » Fri Jun 26, 2015 6:28 am

sawhorse wrote:Is it worthwhile (i.e., interesting and/or informative to readers) for me to look at dollar cost averaging--not periodically investing income but dollar cost averaging--over X number of years? The assumption would be that the non-stock amount is in cash earning interest at the money market rate. (This would not be the case with periodically investing income because you wouldn't have the other money earning anything.) I would look at how much you'd have if you dollar cost averaged over 2 years, 5 years, 10 years, etc. As others have said, it's kind of unrealistic because someone in that situation wouldn't choose to dollar cost average over 25 years. On the other hand, it's kind of interesting that if someone did in fact do that, they'd be ahead of someone who lump summed because cash has outperformed stocks over the 25 year period. I was thinking of trying to find the "optimal" number of years to dollar cost average over.
When I think about it, I quickly discover that putting money in a savings account for 25 years provides inferior returns (in the vast majority of historical scenarios world-wide) than putting the money in a high-quality bond fund over such a long period, way beyond the duration of the fund.

If we made the replacement (bonds instead of cash), then the main difference between 25-year DCA and a sliding asset allocation is rebalancing; DCA does not rebalance while a sliding allocation does.

As a Boglehead, I would be more interested in a graph of a sliding allocation (with rebalancing), going from 75/25 down to 50/50 (instead of an unrealistic glide from 100/0 down to 0/100 in 25 years).

Actually, I would like the whole thing: a regular investment chart (10,000 contribution per year) with a sliding allocation from 75/25 down to 50/50. That would be a recommended Boglehead portfolio (even though a recent thread reveals more aggressive allocations, now that we've had a long streak of high stock returns). Based on previous work by Rodc, and without any calculation, I expect the final balance to be near that of a constant 62.5/37.5 allocation (e.g. the average allocation of the sliding allocation); make that 60/40 if you like round numbers. :)
sawhorse wrote:In such a case, how do you treat the earnings on cash--do you keep them in cash and dump the same amount into the stock market the beginning of each year regardless of earnings on cash, or do you transfer the earnings on cash to the stuff that gets dumped into the stock market?
I don't know the answer to your question.

I am definitely not a fan of cash as part of a portfolio; I am a fan of using a high-quality bond fund with an appropriate duration, instead.

I do keep enough cash around for short-term expenses (between 3 months to 1 year of expenses). Otherwise, I do not use "buckets" (nor do I plan to, when I'll retire), as they do not make mathematical sense to me.
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Re: The Other Side, part 2

Post by leonard » Fri Jun 26, 2015 11:27 am

In taxable, DCA creates too many tax lots and thus more tracking of basis over time.

Lump sum at a conservative enough stock/bond allocation.
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Re: The Other Side, part 2

Post by sawhorse » Fri Jun 26, 2015 11:54 am

longinvest wrote:When I think about it, I quickly discover that putting money in a savings account for 25 years provides inferior returns (in the vast majority of historical scenarios world-wide) than putting the money in a high-quality bond fund over such a long period, way beyond the duration of the fund.

If we made the replacement (bonds instead of cash), then the main difference between 25-year DCA and a sliding asset allocation is rebalancing; DCA does not rebalance while a sliding allocation does.

As a Boglehead, I would be more interested in a graph of a sliding allocation (with rebalancing), going from 75/25 down to 50/50 (instead of an unrealistic glide from 100/0 down to 0/100 in 25 years).

Actually, I would like the whole thing: a regular investment chart (10,000 contribution per year) with a sliding allocation from 75/25 down to 50/50. That would be a recommended Boglehead portfolio (even though a recent thread reveals more aggressive allocations, now that we've had a long streak of high stock returns). Based on previous work by Rodc, and without any calculation, I expect the final balance to be near that of a constant 62.5/37.5 allocation (e.g. the average allocation of the sliding allocation); make that 60/40 if you like round numbers. :)
Glidepaths are on my to-do list :)

Also on my to-do list is dollar cost averaging a windfall into the stock market over a period of say, 1-5 years with the rest in cash. I don't think five years is too long to stretch out a dollar cost averaging scenario for a windfall whereas a 25 year period is.

Stocks vs. cash is sort of interesting because they represent what are supposed to be the two extremes of risk/return. You'd expect that someone who lumped sum everything into stocks in 1990 is ahead of someone who lumped everything into a savings account, but in Japan that hasn't been the case, not by a long shot. That itself is fascinating to me. I agree that high quality bond funds are almost always better in the long run than cash, and that has been true for Japan too.

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Re: The Other Side, part 2

Post by sawhorse » Fri Jun 26, 2015 9:43 pm

The next thread is up! It's actually a revision of this thread. Hopefully there's less confusion. Enjoy!

viewtopic.php?f=10&t=168496

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Re: The Other Side, part 2

Post by Waba » Sun Jun 28, 2015 3:07 pm

Simplegift wrote:Japanese retirees in the 1930s-1940s would have wanted their bond allocation in TIPS (if only they were available).
Would they had really? After the fact it is easy to reach that conclusion, but at the time? The type of turmoil would be somewhat comparable to Greece at the moment. As a Greek citizen, would you buy Greek TIPS if the government offered them? Would you feel confident they would work as advertised if Greece where to transition back to a drachma?

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JoMoney
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Re: The Other Side, part 2

Post by JoMoney » Sun Jun 28, 2015 3:27 pm

Simplegift wrote:...Japanese retirees in the 1930s-1940s would have wanted their bond allocation in TIPS (if only they were available).
Don't forget that prior to the 1930's, having a 'Gold Clause' as part of a bond to hedge against paper currency inflation was a regular occurrence... but that didn't work out so well in the 1930s-1940s
https://en.wikipedia.org/wiki/Liberty_b ... berty_Bond
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Re: The Other Side, part 2

Post by Waba » Sun Jun 28, 2015 8:07 pm

JoMoney wrote:
Simplegift wrote:...Japanese retirees in the 1930s-1940s would have wanted their bond allocation in TIPS (if only they were available).
Don't forget that prior to the 1930's, having a 'Gold Clause' as part of a bond to hedge against paper currency inflation was a regular occurrence... but that didn't work out so well in the 1930s-1940s
https://en.wikipedia.org/wiki/Liberty_b ... berty_Bond
Thanks for the link, I wasnt even aware that the US had defaulted that recently.

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