Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used [vs. lump sum]

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adherenceEnergy
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Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used [vs. lump sum]

Post by adherenceEnergy » Mon Jun 01, 2020 1:43 pm

I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?

Edit: Maybe this example may be more clear to highlight the mental accounting bias. If you had a 100k portfolio of vtsax and inherited 200k cash or 200k vtsax, your decision going forward should be the same. You can essentially pick which one you receive with a few mouseclicks. However, many more people would dca the 200k cash than would convert the 200k vtsax to cash so they could dca right back into vtsax. These are of course the same decisions from a risk and return perspective though.
Last edited by adherenceEnergy on Tue Jun 02, 2020 3:55 am, edited 6 times in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by bloom2708 » Mon Jun 01, 2020 4:53 pm

Most think of Dollar Cost Averaging as investing when you have "new" money.

New might mean "from your paycheck". New might mean a gift you received or the proceeds from selling something. Property or stock options or RSU.

DCA when you bail out (wrong asset allocation) and then DCA back in would not fit the traditional definition of DCA.

When I get paid, some goes to 401k, HSA, taxable/brokerage, regular savings. Some goes to pay bills.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by TropikThunder » Mon Jun 01, 2020 4:59 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
You’re missing the fact that this has been discussed ad nauseum with someone always raising the point you just did.

Oh, and blanket statements are always wrong.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 5:05 pm

TropikThunder wrote:
Mon Jun 01, 2020 4:59 pm
You’re missing the fact that this has been discussed ad nauseum with someone always raising the point you just did.

Oh, and blanket statements are always wrong.
I didn't see this come up in the 15+ articles I read on lump sum vs dca and didn't see it in the bogleheads wiki. I'm sure other people have recognized this idea before.

In what scenario is it rational to dca? That was what I was asking, because I don't think there is one.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by nisiprius » Mon Jun 01, 2020 5:13 pm

To fix our ideas, suppose that the stock market has a return of roughly 10% per year; call it 0.2% per week. Suppose it has a standard deviation of 1% per trading day. Suppose (what is not true) that the daily movements are more or less independent of each other. And suppose that the riskless asset has a return of 1% per year.

If you have, say, $200,000 and you put it all in at once, you experience a standard deviation of 1% depending on the day you happen to put it in.

If you put it in four installments of $50,000 at one-week intervals, you have reduced your standard deviation to 0.5%. You have also delayed your investment by an average of 1.5 weeks, and have therefore foregone 0.3% in return, i.e. you've paid $600 to reduce risk. That might be a tradeoff that some sane investors might be willing to make.

Your hypothetical example of taking the $200,000 out is not equivalent, because you are experiencing a risk, represented by that 1% standard deviation, based on the luck of the day when you decide to take it out. You don't incur that risk if the money was not in stocks to begin with.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by ResearchMed » Mon Jun 01, 2020 5:17 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 5:05 pm
TropikThunder wrote:
Mon Jun 01, 2020 4:59 pm
You’re missing the fact that this has been discussed ad nauseum with someone always raising the point you just did.

Oh, and blanket statements are always wrong.
I didn't see this come up in the 15+ articles I read on lump sum vs dca and didn't see it in the bogleheads wiki. I'm sure other people have recognized this idea before.

In what scenario is it rational to dca? That was what I was asking, because I don't think there is one.
Here is one reason to DCA:

Over time and on average, lump summing (LS) beats DCA, because the market has tended over time to go up.
(If the market were to go down *long* term, this may change. Always be careful not to confuse what "did" happen with what might happen, etc.)

But that is an AVERAGE. It won't apply to everyone. In particular, it won't apply to someone who happens to LS at a real local high, vs. LS'ing starting then and going, say, through the downturn.

So there is a trade-off. Point is, DCA is *not* definitely going to do worse than LSing, even though the probabilities suggest that in many/most cases, it will.
It's no different from other conservative strategies... not going for the bigger profit while also hoping to avoid a larger loss... going for a middle ground of sorts.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by tvubpwcisla » Mon Jun 01, 2020 5:19 pm

DCA is great for putting money into your 401K with each paycheck every couple weeks. I think most investors do this. I like lump sum for larger windfalls of cash.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by terran » Mon Jun 01, 2020 5:33 pm

I don't agree that putting money in slowly as you earn it is the same as DCA. That's lump sum investing everything you have available to invest.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by MathIsMyWayr » Mon Jun 01, 2020 5:37 pm

Each contribution is a lump sum and the history is DCA.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by sailaway » Mon Jun 01, 2020 5:39 pm

terran wrote:
Mon Jun 01, 2020 5:33 pm
I don't agree that putting money in slowly as you earn it is the same as DCA. That's lump sum investing everything you have available to invest.
Right? I mean of DCA and lump sum are two different strategies, you can only choose based on what you actually have at the time.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 5:42 pm

nisiprius wrote:
Mon Jun 01, 2020 5:13 pm
Your hypothetical example of taking the $200,000 out is not equivalent, because you are experiencing a risk, represented by that 1% standard deviation, based on the luck of the day when you decide to take it out. You don't incur that risk if the money was not in stocks to begin with.
How do you experience that 1% SD when you sell? Once you click sell, there's no more risk. You're only experiencing the risk while you're already invested which is equivalent to DCA.
Last edited by adherenceEnergy on Mon Jun 01, 2020 5:43 pm, edited 1 time in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by FiveK » Mon Jun 01, 2020 5:43 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 5:05 pm
TropikThunder wrote:
Mon Jun 01, 2020 4:59 pm
You’re missing the fact that this has been discussed ad nauseum with someone always raising the point you just did.

Oh, and blanket statements are always wrong.
I didn't see this come up in the 15+ articles I read on lump sum vs dca and didn't see it in the bogleheads wiki. I'm sure other people have recognized this idea before.

In what scenario is it rational to dca? That was what I was asking, because I don't think there is one.
Did you see Dollar cost averaging - Bogleheads?
Lump sum investing will always carries a higher expected return, because it immediately moves your funds from asset classes with lower expected returns to ones with higher expected returns. Note that higher expected returns do not guarantee that your actual returns will be higher. According to an investopedia article,[5] studies indicate that lump sum investing has produced higher returns 66% of the time.

Some investors are willing to sacrifice some expected return in order to reduce their potential loss, knowing that higher expected return come with higher potential loss. For those investors, dollar cost averaging is superior because it reduces the chances of investing just prior to a market drop. If you instead decide to invest 1/6th of the money each month for 6 months, you will reduce the chance of buying just before a crash. Instead, as the price fluctuates each month, you will buy more shares when the price is low and less when it is high. In such volatile markets your real return can be higher then the normally expected return.

Many new investors are more interested in minimizing their potential loss, and it's important that an ill-timed market drop not scare them off from investing in the future. Many experienced investors are more interested in maximizing their expected returns. You can also decide to split the difference, where you invest half immediately and the other half over 6 or so months.
Would you suggest any particular edits to that?

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by FIREchief » Mon Jun 01, 2020 5:50 pm

Really? Of all the awful behaviors that novice investors engage in, we're going to pick on those who might "feel better" if they're just adding a bit of stocks over time?

Don't get me wrong OP, as your argument is perfectly logical. I'm right there with you. I'm not in accumulation mode any more, but when I was I would immediately lump sum invest any "extra" assets and I continue to execute my entire annual Roth conversions each year on Jan 2. In the vast majority of times, those strategies have paid off $$$. But still..... :annoyed
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by David Jay » Mon Jun 01, 2020 5:57 pm

TropikThunder wrote:
Mon Jun 01, 2020 4:59 pm
Oh, and blanket statements are always wrong.
nice touch...
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Steve Reading » Mon Jun 01, 2020 6:03 pm

nisiprius wrote:
Mon Jun 01, 2020 5:13 pm
Your hypothetical example of taking the $200,000 out is not equivalent, because you are experiencing a risk, represented by that 1% standard deviation, based on the luck of the day when you decide to take it out. You don't incur that risk if the money was not in stocks to begin with.
Haha, I understand what you're saying (took me a while) but it's not what OP is saying.

What you're saying:
Person A with 300k in 80/20 goes through day 1 with it, sells 200k at the end of day 1. Now he has 200k in cash + ~100k in 80/20 (depending on how that day went of course).
Person B goes though day 1 with 100k in 80/20 and is gifted 200k at end of day. Now he has 200k in cash + ~100k in 80/20.

The ~100k that those two people have is different obviously because person A has more invested through day 1. No argument here. These aren't equivalent scenarios.

What OP is saying:
Person A has 300k in 80/20 AT THE END of day 1. And he sells 200k right at the end to begin the next day exactly with 100k in 80/20 and 200k in cash.
Person A has 100k in 80/20 AT THE END of day 1. And he's gifted 200k right at the end of the day. He begins the next day exactly with 100k in 80/20 and 200k in cash.

OP's point is that if you argue Person B should DCA, you'd argue Person A should also DCA. But Person A could just LS and it would be as though he never pulled money out. It'd be like a 300k 80/20 BH portfolio that stayed the course. So if you argue Person B should DCA, you'd argue some BH 80/20 investor who has $X towards the end of a day, should pull some out, and DCA back in.
Last edited by Steve Reading on Mon Jun 01, 2020 6:05 pm, edited 1 time in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by whereskyle » Mon Jun 01, 2020 6:03 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
You are missing nothing, and I agree 100%. People who are considering dollar-cost averaging should simply acknowledge that their chosen asset allocation is too risky for their tolerance. That is why they don't want to actually implement the portfolio and would prefer to keep a higher portion of their assets in cash. People in this situation should simply up their bond/cash allocation, enter the market, and reconsider their risk tolerance in a year to identify the appropriate portfolio for them.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Steve Reading » Mon Jun 01, 2020 6:12 pm

ResearchMed wrote:
Mon Jun 01, 2020 5:17 pm
adherenceEnergy wrote:
Mon Jun 01, 2020 5:05 pm
TropikThunder wrote:
Mon Jun 01, 2020 4:59 pm
You’re missing the fact that this has been discussed ad nauseum with someone always raising the point you just did.

Oh, and blanket statements are always wrong.
I didn't see this come up in the 15+ articles I read on lump sum vs dca and didn't see it in the bogleheads wiki. I'm sure other people have recognized this idea before.

In what scenario is it rational to dca? That was what I was asking, because I don't think there is one.
Here is one reason to DCA:

Over time and on average, lump summing (LS) beats DCA, because the market has tended over time to go up.
(If the market were to go down *long* term, this may change. Always be careful not to confuse what "did" happen with what might happen, etc.)

But that is an AVERAGE. It won't apply to everyone. In particular, it won't apply to someone who happens to LS at a real local high, vs. LS'ing starting then and going, say, through the downturn.

So there is a trade-off. Point is, DCA is *not* definitely going to do worse than LSing, even though the probabilities suggest that in many/most cases, it will.
It's no different from other conservative strategies... not going for the bigger profit while also hoping to avoid a larger loss... going for a middle ground of sorts.

RM
There's nothing particularly wrong with this logic but that's not addressing OP. OP's point is once you have fully DCAed back in, why wouldn't you pull some out and DCA in again? Wouldn't that also be sacrificing some returns but also decreasing your risk? If you're 100% in stocks (say you have 200k), then why not pull out 100k and DCA that in. Lower returns ON AVERAGE as you say, but that will also have lower risk. Doing this will not definitely underperform just keeping the 200k, for the same reasons you quote. Everything you said applies identically.

I don't think OP proved that DCA is irrational. It might be (I believe it is). But he didn't prove it. What he did prove is that if you believe DCA is a reasonable strategy, then you must also believe it reasonable to randomly pull money out of your portfolio into cash, and DCA back in. If you ALSO agree with that, fine! But many people who recommend DCA will also then say "once you're fully in, just stay the course!". OP's point is that such a mentality is actually inconsistent.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by reln » Mon Jun 01, 2020 6:20 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
Agreed

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 6:26 pm

FiveK wrote:
Mon Jun 01, 2020 5:43 pm
Would you suggest any particular edits to that?
I'm not great at writing wiki ideas. If I had the ability to edit it, I would probably put this idea in a separate subsection: "Criticisms of dca" - "The entire point of dca is based on a mental accounting fallacy of treating a specific set of money differently, but money is fungible. Let's say today you had 300k invested in the market. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having 100k invested, getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? This example highlights the mental accounting bias at play. If you are worried about risk, the optimal way to alleviate that risk is find the appropriate allocation you feel safe with and investing it at that allocation immediately. "

But again, I'm not a great wiki writer, and I'm sure someone can come up with a clearer way to explain the idea.
Last edited by adherenceEnergy on Mon Jun 01, 2020 6:52 pm, edited 3 times in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 6:31 pm

FIREchief wrote:
Mon Jun 01, 2020 5:50 pm
Really? Of all the awful behaviors that novice investors engage in, we're going to pick on those who might "feel better" if they're just adding a bit of stocks over time
I definitely don't think it's a big deal for a novice investor to get their feet wet dca and likely wouldn't try to discourage a noobie from doing it. But I see many many people asking for advice on dca that have been investing for 10+ years, get a windfall of like 25% of their portfolio and are wondering if they should dca it. I think being able to link a well written bogleheads subsection on the topic could help teach people faster that it's completely illogical. I think when people see the fallacy, they can mentally accept the risk better, they won't dca, and it saves them time and (expected) money.
Last edited by adherenceEnergy on Mon Jun 01, 2020 6:41 pm, edited 1 time in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by tvubpwcisla » Mon Jun 01, 2020 6:40 pm

terran wrote:
Mon Jun 01, 2020 5:33 pm
I don't agree that putting money in slowly as you earn it is the same as DCA. That's lump sum investing everything you have available to invest.
Good point. Thanks for clarifying this.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by wander » Mon Jun 01, 2020 7:00 pm

I use DCA for contributing our Roth IRAs because I am lazy and don't really care about getting money into the Roth IRAs by January 02 every year. The markets can be up or down for the year but my contribution is fixed and consistent.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by 9-5 Suited » Mon Jun 01, 2020 7:47 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
Your logic is entirely correct, and would apply perfectly to robots. The thing you aren't accounting for when you say "should never be used" is that human beings invest, and human beings have emotions. Those emotions have merit in making personal finance decisions. It can take a while to becoming accustomed to having a significantly higher nominal dollar value portfolio. The swings are much larger in dollar terms. Someone who already had a large portfolio may be more used to that than someone who ended up with $500K when Aunt Bertha died.

As with a lot of criticisms of "mental accounting", the point is to be aware of the mental accounting, not necessarily to avoid it.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Ben Mathew » Mon Jun 01, 2020 7:52 pm

FiveK wrote:
Mon Jun 01, 2020 5:43 pm
Did you see Dollar cost averaging - Bogleheads?
Lump sum investing will always carries a higher expected return, because it immediately moves your funds from asset classes with lower expected returns to ones with higher expected returns. Note that higher expected returns do not guarantee that your actual returns will be higher. According to an investopedia article,[5] studies indicate that lump sum investing has produced higher returns 66% of the time.

Some investors are willing to sacrifice some expected return in order to reduce their potential loss, knowing that higher expected return come with higher potential loss. For those investors, dollar cost averaging is superior because it reduces the chances of investing just prior to a market drop. If you instead decide to invest 1/6th of the money each month for 6 months, you will reduce the chance of buying just before a crash. Instead, as the price fluctuates each month, you will buy more shares when the price is low and less when it is high. In such volatile markets your real return can be higher then the normally expected return.

Many new investors are more interested in minimizing their potential loss, and it's important that an ill-timed market drop not scare them off from investing in the future. Many experienced investors are more interested in maximizing their expected returns. You can also decide to split the difference, where you invest half immediately and the other half over 6 or so months.
Would you suggest any particular edits to that?
IMO the second paragraph above is misleading because it presents DCA as a valid method for reducing risk. The reality is that holding expected return constant, DCA increases risk. Overall risk would have been lower if the investor had invested lump sum at a safer AA than by sharply changing AA over the course of 12 months. $100K invested at 50/50 for a year has about the same expected return as $100K invested at 25/75 for 4 months, 50/50 for 4 months, and 75/25 for 4 months. But the risk is lower. I don't think DCA can be defended from a rational risk/return perspective.

The third paragraph that casts DCA more as a psychological technique that can help new investors get their feet wet without being scared off, is okay.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 8:01 pm

9-5 Suited wrote:
Mon Jun 01, 2020 7:47 pm

Your logic is entirely correct, and would apply perfectly to robots. The thing you aren't accounting for when you say "should never be used" is that human beings invest, and human beings have emotions. Those emotions have merit in making personal finance decisions. It can take a while to becoming accustomed to having a significantly higher nominal dollar value portfolio. The swings are much larger in dollar terms. Someone who already had a large portfolio may be more used to that than someone who ended up with $500K when Aunt Bertha died.

As with a lot of criticisms of "mental accounting", the point is to be aware of the mental accounting, not necessarily to avoid it.
This is an excellent counterpoint that changed my view. I guess instead of saying "should never be used," what I should have said is dca shouldn't generally be recommended without first attempting to explain the mental accounting bias at play and seeing if they can overcome the mental hurdle when they understand it. The advice of never using dca is definitely more targeted at people with a more advanced understanding in investing concepts and I actually said earlier in the thread I probably wouldn't even try to correct a noobie investor about the issue, preferring they just get their feet wet with investing.
Last edited by adherenceEnergy on Mon Jun 01, 2020 8:06 pm, edited 2 times in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by JoMoney » Mon Jun 01, 2020 8:03 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
...
I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play...
If "it makes you feel better", that's at least one potential reason to do it. Sometimes there's a cost associated with things that make you feel better.
Using "mental account" doesn't inherently make something wrong, or even non-optimal, it's just something to be aware of as it might but (not necessarily) be less optimal.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by jacoavlu » Mon Jun 01, 2020 8:07 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
it's a reasonable point, I like to invert things as well, it can help with decision making

but you must see a problem, because the logical extension of your argument may be, why shouldn't the person be leveraging up?

I mean, maybe they're also not pulling funds out of the portfolio to pay off debt. Debt is cheap and the long term expected returns of 80/20 is going to be greater than the cost of debt. So, logic would follow to leverage up, take on more debt and invest more. Right?

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by 9-5 Suited » Mon Jun 01, 2020 8:16 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 8:01 pm
9-5 Suited wrote:
Mon Jun 01, 2020 7:47 pm

Your logic is entirely correct, and would apply perfectly to robots. The thing you aren't accounting for when you say "should never be used" is that human beings invest, and human beings have emotions. Those emotions have merit in making personal finance decisions. It can take a while to becoming accustomed to having a significantly higher nominal dollar value portfolio. The swings are much larger in dollar terms. Someone who already had a large portfolio may be more used to that than someone who ended up with $500K when Aunt Bertha died.

As with a lot of criticisms of "mental accounting", the point is to be aware of the mental accounting, not necessarily to avoid it.
This is an excellent counterpoint that changed my view. I guess instead of saying "should never be used," what I should have said is dca shouldn't generally be recommended without first attempting to explain the mental accounting bias at play and seeing if they can overcome the mental hurdle when they understand it. The advice of never using dca is definitely more targeted at people with a more advanced understanding in investing concepts and I actually said earlier in the thread I probably wouldn't even try to correct a noobie investor about the issue, preferring they just get their feet wet with investing.
Yep, that’s spot on. Glad you started this interesting thread, and glad I could chime in with a useful amendment :beer

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 8:17 pm

jacoavlu wrote:
Mon Jun 01, 2020 8:07 pm
but you must see a problem, because the logical extension of your argument may be, why shouldn't the person be leveraging up?
It's not logically equivalent. Let's say you have 100k in an 80 stock /20 bond /0 cash portfolio and get that 200k cash windfall. Dca means you now have a 26 stock/7 bond/ 67 cash portfolio, then next deposit you have a 32/8/60 portfolio, etc. Leveraging changes desired allocation just like dca does, just in the other direction. If you leverage, you'd now have like a 90/25/-15 portfolio or however you want to annotate it. Ideally you should always be at your desired allocation and risk profile, windfalls shouldn't change that desire, and leveraging changes your allocation.
Last edited by adherenceEnergy on Mon Jun 01, 2020 8:19 pm, edited 1 time in total.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Ben Mathew » Mon Jun 01, 2020 8:19 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 8:01 pm
dca shouldn't generally be recommended without first attempting to explain the mental accounting bias at play and seeing if they can overcome the mental hurdle when they understand it.
I agree with this. There is a lot of confusion surrounding DCA. It's possible that once people understand the mechanics of why it is suboptimal, they will become more psychologically more comfortable with lump summing, and might decide to either lump sum or at least DCA in faster.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by jacoavlu » Mon Jun 01, 2020 8:21 pm

But what if your 300 K 80/20 also has a 200 K mortgage and 200 K in equity in their home? Certainly there are many in such a situation, perhaps the majority of people, have some debt.

That portfolio is not 80/20. Almost everyone is using leverage, we just don’t think of it that way. Isn’t that also just mental accounting?

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by 9-5 Suited » Mon Jun 01, 2020 8:25 pm

jacoavlu wrote:
Mon Jun 01, 2020 8:21 pm
But what if your 300 K 80/20 also has a 200 K mortgage and 200 K in equity in their home? Certainly there are many in such a situation, perhaps the majority of people, have some debt.

That portfolio is not 80/20. Almost everyone is using leverage, we just don’t think of it that way. Isn’t that also just mental accounting?
The leverage scenario isn’t an extension of the OP’s argument because leverage adds both additional cost and risk. The two scenarios the OP has shared are cost and risk equivalent, just reversing the transaction order.

But yes, not counting a mortgage as leverage and designating “emergency funds” outside of ones asset allocation are two of the most common instances of mental accounting.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Steve Reading » Mon Jun 01, 2020 8:31 pm

jacoavlu wrote:
Mon Jun 01, 2020 8:07 pm
adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
it's a reasonable point, I like to invert things as well, it can help with decision making

but you must see a problem, because the logical extension of your argument may be, why shouldn't the person be leveraging up?

I mean, maybe they're also not pulling funds out of the portfolio to pay off debt. Debt is cheap and the long term expected returns of 80/20 is going to be greater than the cost of debt. So, logic would follow to leverage up, take on more debt and invest more. Right?
OP isn't saying to use LS because it produces higher returns than DCA. If that were true, then the logical conclusion, as you say, is to leverage up a portfolio, since that will have even higher returns than LS.

What OP is saying however is that a person who says "go ahead and DCA, it's fine" should also be OK with saying "go ahead and sell a portion of your portfolio today and DCA in back in". If you're not willing to do the latter (I certainly am not. Are you?) then why would you do or recommend anyone do the former?

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by TheTimeLord » Mon Jun 01, 2020 8:31 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias.
It may not make sense to many here but I generally prefer to use DCA over Lump Sum for Risk management reasons.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by tadamsmar » Mon Jun 01, 2020 8:56 pm

adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?
This was proven and published over 40 years ago:

https://faculty.chicagobooth.edu/george ... A_1979.pdf
I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
Statman wrote "Using dollar-cost-averaging is like putting on eyeglasses. Eyeglasses will distort the sight of people with 20/20 vision, but improve the sight of people with less than 20/20 vision. Eyeglasses correct one distortion by introducing another. It is a case of two wrongs that can make a right; it just depends on the individual. If dollar-cost averaging makes it easier to get started and put money to work, it can be a useful behavioral tool." https://blog.wealthfront.com/dollar-cos ... oral-view/

Of course, Statman's view presumes a psychological model of a certain kind of investor. I don't know of any data that shows that investors who DCA because of distorted vision don't have distortions that makes them bad stock investors.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by tadamsmar » Mon Jun 01, 2020 9:04 pm

TropikThunder wrote:
Mon Jun 01, 2020 4:59 pm
Oh, and blanket statements are always wrong.
That's a blanket statement.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by mikeyzito22 » Mon Jun 01, 2020 9:08 pm

Ben Mathew wrote:
Mon Jun 01, 2020 8:19 pm
adherenceEnergy wrote:
Mon Jun 01, 2020 8:01 pm
dca shouldn't generally be recommended without first attempting to explain the mental accounting bias at play and seeing if they can overcome the mental hurdle when they understand it.
I agree with this. There is a lot of confusion surrounding DCA. It's possible that once people understand the mechanics of why it is suboptimal, they will become more psychologically more comfortable with lump summing, and might decide to either lump sum or at least DCA in faster.
So, maybe it is just that people in general (many not on this board) are investing when they are paid. They are DCA'ing contributions because that's what people can afford in their budget. My mortgage is X, my fixed costs are X, what's left gets thrown at the market. Is there something wrong with this? This is how most people invest. If you are talking about a windfall and then hesitating, that's a completely different matter.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by jacoavlu » Mon Jun 01, 2020 9:09 pm

9-5 Suited wrote:
Mon Jun 01, 2020 8:25 pm
jacoavlu wrote:
Mon Jun 01, 2020 8:21 pm
But what if your 300 K 80/20 also has a 200 K mortgage and 200 K in equity in their home? Certainly there are many in such a situation, perhaps the majority of people, have some debt.

That portfolio is not 80/20. Almost everyone is using leverage, we just don’t think of it that way. Isn’t that also just mental accounting?
The leverage scenario isn’t an extension of the OP’s argument because leverage adds both additional cost and risk. The two scenarios the OP has shared are cost and risk equivalent, just reversing the transaction order.

But yes, not counting a mortgage as leverage and designating “emergency funds” outside of ones asset allocation are two of the most common instances of mental accounting.
I think the leverage scenario is a perfectly reasonable extension of the OP's argument. Unless the OP's argument is isolated to someone that has 300k invested assets and zero debt.

The OP's argument boils down to "lump sum has a higher expected return than DCA" and references "mental accounting bias" but to ignore the decisions that we make around debt and investing is just as reasonably characterized as "mental accouting bias"

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by jacoavlu » Mon Jun 01, 2020 9:13 pm

Steve Reading wrote:
Mon Jun 01, 2020 8:31 pm
jacoavlu wrote:
Mon Jun 01, 2020 8:07 pm
adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
I think DCA makes 0 sense in any circumstance and is an entirely a mental accounting bias. Let's say today you had 300k in an 80/20 portfolio. Would you ever think, now is the time to take less risk, pull 200k out, and slowly put it back in? That's equivalent to having a 100k 80/20 portfolio and getting a 200k windfall and DCA the windfall. If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario? The only difference is feeling that "this particular amount of money has less risk" but money is fungible, so why would that be important?

I think it should be never used, as it's only benefit is to make you feel better because you don't understand the mental accounting bias at play.

Am I missing something? Any other thoughts?
it's a reasonable point, I like to invert things as well, it can help with decision making

but you must see a problem, because the logical extension of your argument may be, why shouldn't the person be leveraging up?

I mean, maybe they're also not pulling funds out of the portfolio to pay off debt. Debt is cheap and the long term expected returns of 80/20 is going to be greater than the cost of debt. So, logic would follow to leverage up, take on more debt and invest more. Right?
OP isn't saying to use LS because it produces higher returns than DCA. If that were true, then the logical conclusion, as you say, is to leverage up a portfolio, since that will have even higher returns than LS.

What OP is saying however is that a person who says "go ahead and DCA, it's fine" should also be OK with saying "go ahead and sell a portion of your portfolio today and DCA in back in". If you're not willing to do the latter (I certainly am not. Are you?) then why would you do or recommend anyone do the former?
OP is actually saying "never DCA" and it seems to me it boils down to expected returns

Perhaps the OP could chime in regarding their logic, and the mental accounting bias of ignoring debt when investments are considered.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by celia » Mon Jun 01, 2020 9:13 pm

OP, Do you automatically re-invest dividends in any of your accounts? Isn’t that DCA-ing?

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by rbaldini » Mon Jun 01, 2020 9:24 pm

celia wrote:
Mon Jun 01, 2020 9:13 pm
OP, Do you automatically re-invest dividends in any of your accounts? Isn’t that DCA-ing?
No. It's putting the money back into the market as soon as it becomes available. It is lump-summing.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by rbaldini » Mon Jun 01, 2020 9:29 pm

Agreed.

DCA says "I'm ok with money I've had for a while being fully invested right now. But I am not okay with money I just received being fully invested right now - in fact, I won't be ok with that for another 6 months (or whatever)"

The fallacy lies in the fact that there is no real difference between the money you just received and the money you've had for a while. It's all just your money. Make the best use of it right now.

If going fully invested (in whatever AA you choose) makes you weak in the knees right now, why wouldn't you feel the same 6 months from now? Pick an asset allocation you are comfortable with *right now*, and go all in.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Steve Reading » Mon Jun 01, 2020 9:45 pm

jacoavlu wrote:
Mon Jun 01, 2020 9:13 pm

OP is actually saying "never DCA" and it seems to me it boils down to expected returns

Perhaps the OP could chime in regarding their logic, and the mental accounting bias of ignoring debt when investments are considered.
OP is saying to never DCA but it does not have anything to do with expected returns. It has everything to do with the fact that, as he put it:
adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario?
Note how expected returns has nothing to do with it. If LS somehow had lower expected returns yet you still wouldn't pull out 200k randomly and DCA (for whatever reason), then you shouldn't DCA when given a cash gift of 200k either. The argument holds.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by sport » Mon Jun 01, 2020 9:56 pm

I had a situation where DCA made perfect sense to me. My two children were very young and their elderly grandmother decided that she would not live to see them get married (she was correct). So, she gave me a nice "wedding gift" to invest for each of them. I chose a stock fund because 100% stocks was appropriate for their ages. However, since this was a one-time event, the one thing I wanted to avoid was investing all of it and have the market turn south. Maximizing gain was less important to me than avoiding a big loss. So, I invested half of the money and a year later I invested the other half. As it turned out, I would have done better to invest it all at once. However, I would have been very unhappy with myself if I lost 20% or 30% of Grandma's gift to my children. It may have been mental accounting, but I was much more comfortable with it. Many years later, one of them used it towards a down payment on their house. The other one still has the account.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by jacoavlu » Mon Jun 01, 2020 10:03 pm

Steve Reading wrote:
Mon Jun 01, 2020 9:45 pm
jacoavlu wrote:
Mon Jun 01, 2020 9:13 pm

OP is actually saying "never DCA" and it seems to me it boils down to expected returns

Perhaps the OP could chime in regarding their logic, and the mental accounting bias of ignoring debt when investments are considered.
OP is saying to never DCA but it does not have anything to do with expected returns. It has everything to do with the fact that, as he put it:
adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario?
Note how expected returns has nothing to do with it. If LS somehow had lower expected returns yet you still wouldn't pull out 200k randomly and DCA (for whatever reason), then you shouldn't DCA when given a cash gift of 200k either. The argument holds.
how about this. I'll try answering the OP's question directly.
adherenceEnergy wrote:
Mon Jun 01, 2020 1:43 pm
If you wouldn't randomly take 200k out of equities and DCA back in, why would you do that in the windfall scenario?
If I received a "windfall" - the actual dollar amount may be different for me or you - I would probably DCA over six months. I really probably would. Because if I lump summed and the market dropped 30% in a month or 50% in six months, I would feel really really bad. Like really really bad. By contrast I wouldn't feel really really bad if my DCA over six months turned out to miss out on some returns. And I actually wouldn't feel really really bad if my existing portfolio dropped 30% or 50%. I've accepted that that is a real possibility, as a matter of fact it is likely to occur at some point, given my chosen AA.


To be clear I would never remove a windfall amount from my portfolio, and then DCA it back in. In other words I don't try to time the market in that way.

So now tell me, why is DCA'ing wrong for me in a windfall scenario?

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by 1130Super » Mon Jun 01, 2020 10:13 pm

Sometimes logic doesn’t prevail. Similar to the argument “should I pay extra or even payoff a 3.5% mortgage”

over 30 years the likelihood of a 3.5% return outperforming the stock market is way more unlikely then the DCA outperforms a lump sum

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by Steve Reading » Mon Jun 01, 2020 10:23 pm

jacoavlu wrote:
Mon Jun 01, 2020 10:03 pm
If I received a "windfall" - the actual dollar amount may be different for me or you - I would probably DCA over six months....

To be clear I would never remove a windfall amount from my portfolio, and then DCA it back in.


So now tell me, why is DCA'ing wrong for me in a windfall scenario?
The two statements I bolded above are inconsistent with one another. If you're willing to do the former, then you should be willing to do the latter. If you'd never do the latter (as you claim) then you should never do the former. Though the scenarios appear different due to the way they're presented, they're actually equivalent. This has nothing to do with expected returns. At all.

Think about it. Imagine twins A and B are identical twins, in every way:
Twin A has 100k in the market and receives a 100k windfall. He decides to DCA it.
Twin B, on the other hand, has 200k in the market. What should twin B do right now?

The only decision that is equivalent to what twin A is doing is to pull out 100k from stocks and DCA that. If he didn't do that, he would be following a different investment plan than twin A, even though they're identical and have the same amount of money.

In other words, the way I've presented how you have the money (whether you had it all along in stocks OR you suddenly received it) makes you invest it differently (in the former, you stay fully in stocks, in the latter, you DCA).

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by David Jay » Mon Jun 01, 2020 10:31 pm

terran wrote:
Mon Jun 01, 2020 5:33 pm
I don't agree that putting money in slowly as you earn it is the same as DCA.
That is the very definition of DCA. Go to any financial resource, the illustration of DCA is not a windfall, it is making regular contributions which purchase more shares when the market is down, thus reducing the volatility effect.
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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by jacoavlu » Mon Jun 01, 2020 10:40 pm

Steve Reading wrote:
Mon Jun 01, 2020 10:23 pm
jacoavlu wrote:
Mon Jun 01, 2020 10:03 pm
If I received a "windfall" - the actual dollar amount may be different for me or you - I would probably DCA over six months....

To be clear I would never remove a windfall amount from my portfolio, and then DCA it back in.


So now tell me, why is DCA'ing wrong for me in a windfall scenario?
The two statements I bolded above are inconsistent with one another. If you're willing to do the former, then you should be willing to do the latter. If you'd never do the latter (as you claim) then you should never do the former.
I'm not arguing that the scenarios are different. But I've told you my reason. Lump summing a windfall and seeing the market tank would make me feel really really bad, and I don't wan't to feel really really bad

Accept that as fact. So now, tell me why DCAing a windfall is bad for me.

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Re: Why Dollar Cost Averaging (DCA) is a mental accounting bias and should never be used

Post by adherenceEnergy » Mon Jun 01, 2020 10:40 pm

jacoavlu wrote:
Mon Jun 01, 2020 10:03 pm
So now tell me, why is DCA'ing wrong for me in a windfall scenario?
The only reason to dca is because you are unaware or don't care about the mental accounting bias at play. If you want to make yourself feel better to invest irrationally, then that's the right decision for you. But I'd argue you're making an irrational mistake, the same way I'd argue someone else was making an irrarional mistake if they if they sold all their stocks everytime the market dipped and waited for it to rebound. Yes it might make you feel better, but the decision is not based on any logic. Now the mistake of dca is not a very large mistake and by no means in the same ballpark of a mistake as selling everytime the market dipped, but I think people that are wanting to learn to invest optimally should be aware of it, because I think many people can overcome the irrational fear of a dip on windfall money or should revisit their desired asset allocation strategy.
Last edited by adherenceEnergy on Mon Jun 01, 2020 10:49 pm, edited 1 time in total.

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