Rick's Rules for Lump Sum Investing

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Rick Ferri
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Re: Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Sat Dec 03, 2011 7:58 am

tadamsmar wrote:
Swerdroe tells what is best, while granting that it's better to use DCA than to be too scared to invest at all. Malkiel, Bogle, Ferri offer the sugar pill.


Don''t assume we're not discussing the all-in option with a client before recommending one way or the other. We state the facts, assess client feedback, and THEN make a recommendation.

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Re: Rick's Rules for Lump Sum Investing

Post by tpm871 » Sat Dec 03, 2011 8:37 am

I was in exactly the situation you describe earlier this year: I had changed jobs and rolled over my 401(k) into my IRA. In doing so, about 20% of my portfolio was liquidated in order to make the transfer. I handled it differently than you suggested, and here's how it went:

* I sold equity assets gradually in my 401(k) during April and May, thinking that I prefer to control the selling myself rather than have everything sold on some random day when the transfer will be initiated. That turned out to be lucky timing, since I ended up selling during the market peak of the year.

* I had about 60% of this account in TBM, which I held onto longer. But one day in early May, I got nervous about things like QE2 coming to an end, and I sold all of it. That turned out to be a mistake, since bonds did well over the next few months. Not a huge mistake considering that I needed to sell soon, but I missed some of the upside for bonds that followed.

* So that account was completely liquidated by around mid-May. The rollover to my IRA completed around mid-July. At that time, I faced the lump sum vs averaging choice.

* I chose to do averaging rather than lump sum, but I planned to do value averaging rather than dollar cost averaging. I planned the value averaging path to be completely reinvested over the course of one year.

This has turned out pretty well for me so far. If I had done a lump sum, I would have bought into the market in mid-July only to see it drop like a stone over the next two and a half months. Due to how value averaging works, I ended up making large purchases every time there was a large drop in the market. I was lucky enough to make large purchases on Oct 3 (the market low of the year), for example. My equity balances are now at or above their target allocations since I had bought low. I still have a fair amount of cash left, and I'm gradually buying into a Treasury bond fund and TIPS fund.

So my experience has been mixed: I did well in equities doing averaging, but I could have perhaps done better in bonds in doing lump sum.

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Sat Dec 03, 2011 8:42 am

Rick Ferri wrote:
tadamsmar wrote:
Swerdroe tells what is best, while granting that it's better to use DCA than to be too scared to invest at all. Malkiel, Bogle, Ferri offer the sugar pill.


Don''t assume we're not discussing the all-in option with a client before recommending one way or the other. We state the facts, assess client feedback, and THEN make a recommendation.

Rick Ferri
You don't mention that in your column (or blog) you cited in the OP. I was putting you in the sugar pill category based on your column. For all I know, Bogle would have a more nuanced view if he was asked directly about the matter.

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Re: Rick's Rules for Lump Sum Investing

Post by Rick Ferri » Sat Dec 03, 2011 8:55 am

You're calling my article a sugar-pill approach, but in reality it is the other way around.

A majority of the people who receive a lump sum think they should DCA into the market. This is one of those false "rules of thumb" that you read about in Money magazine. I don't agree. That's why my article was written to nudge the majority toward an all-in approach and away from DCA. I give several situations in which a lump sum works, and those situations mentioned cover 90% of all lump sum distributions in the marketplace.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Sat Dec 03, 2011 10:21 am

JimInIllinois wrote:People don't really want to maximize expected return or risk-adjusted return. They want to minimize regret. The biggest potential cause of regret is the market dropping shortly after investing the entire lump sum, because you could have avoided it by waiting a few weeks. Waiting is good because impatience is bad, so you lost your money because you were impatient and didn't wait for the market drop, which was obvious in hindsight. You won't regret the lump sum if the market drops a year later, because waiting a year to invest would have been unreasonable, so you only really care about a loss that quickly follows an investment. DCA is the logical compromise, and at worst you'll only regret the timing of your last investment before a market drop, which is only 1/12 the size of the lump sum if you DCA over a year.
Investors and advisors alike both exhibit an emotion-driven decision making process. Advisors are often even more vulnerable to behavioral mistakes because they would rather "keep a client happy" instead of offer logical advice. If the market drops right after a large lump sum is invested, the advisor often takes a harder hit emotionally because he feels compelled to say "I'm sorry," even though he has nothing to be sorry for.

If a major role of the advisor is to insprire positive behavior, recommending DCA is a move in the opposite direction. It's not as if you can recommend DCA today and somehow think a client will be cured of anchoring to sunk costs. Recommending bad behavior brings more bad behavior. Advisors who do it often enough and long enough somehow justify it as being OK.

If a client has a reasonable allocation plan for the money in question, then by all means put it to work as soon as possible. Trust the allocation to "do its thing." That allocation, in theory, already anticipates the market imploding tomorrow for any given reason, and targets a level of risk the client needs and can acutally embrace.

What if the market moves sharply higher after starting DCA. Have you minimized regret? No, you now have a new problem - finding yourself rooting for pullback. You go from regret of being in to regret of being out. Worse yet, your client probably just incurred a large cost that dwarfs expense ratio savings, etc.

Investing really can be as simple as 1,2,3. Cut costs, diversify, have a plan. Behavior screws it all up and advisor shouldn't exaggerate the problem.

The default position should be lump sum IMO. DCA might still come into play, but the client understands that is NOT the recommendation. What comes next is someone giving in to a compromise of some sort. Who wins that battle in the long run?

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Re: Rick's Rules for Lump Sum Investing

Post by JimInIllinois » Sat Dec 03, 2011 11:03 am

Derek Tinnin wrote:What if the market moves sharply higher after starting DCA. Have you minimized regret? No, you now have a new problem - finding yourself rooting for pullback. You go from regret of being in to regret of being out. Worse yet, your client probably just incurred a large cost that dwarfs expense ratio savings, etc.
Your account balance is up so you are probably pretty happy.

People are highly skilled at ignoring missed opportunities. It's not nearly as painful as losing money because of something you did.

Ideally the advisor should frame investment results in ways that lead the client to make good decisions in the long term, but this requires tempering their joy as well as their pain.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Sat Dec 03, 2011 11:28 am

JimInIllinois wrote:
Derek Tinnin wrote:What if the market moves sharply higher after starting DCA. Have you minimized regret? No, you now have a new problem - finding yourself rooting for pullback. You go from regret of being in to regret of being out. Worse yet, your client probably just incurred a large cost that dwarfs expense ratio savings, etc.
Your account balance is up so you are probably pretty happy.

People are highly skilled at ignoring missed opportunities. It's not nearly as painful as losing money because of something you did.

Ideally the advisor should frame investment results in ways that lead the client to make good decisions in the long term, but this requires tempering their joy as well as their pain.
up from when? I guess if you place focus on historical values that hold zero relevance today except for tax purposes, I can see how going down this path of temporing joy/pain somehow makes sense. Anchoring to sunk cost might be the number one impediment to logical decisions being made.

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When experts disagree.

Post by Taylor Larimore » Sat Dec 03, 2011 11:33 am

Bogleheads:

When experts disagree, it often means it doesn't make much difference.

Best wishes.
Taylor
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Re: Rick's Rules for Lump Sum Investing

Post by fcirullo » Sat Dec 03, 2011 11:36 am

Rick Ferri wrote:Here are a few simple rules, or guidelines if you prefer, to help decide on a dollar-cost average or all-in strategy:
4 Rules for Investing a Lump Sum
Good article, Rick! Rules and guidelines are good...I like rules and guidelines.

Great discussion, too. It can make us think about how we really feel about gains, losses, and missed opportunities.
Frank R. Cirullo | | "It isn't what we don't know that gives us trouble, it's what we know that ain't so." -- | Will Rogers

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Re: When experts disagree.

Post by Derek Tinnin » Sat Dec 03, 2011 11:43 am

Taylor Larimore wrote:Bogleheads:

When experts disagree, it often means it doesn't make much difference.

Best wishes.
Taylor
Either that, or that there are no experts! :D

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Re: When experts disagree.

Post by bob90245 » Sat Dec 03, 2011 11:51 am

Taylor Larimore wrote:Bogleheads:

When experts disagree, it often means it doesn't make much difference.

Best wishes.
Taylor
Taking a look at lump sum versus DCA since January 2000, we see that there is wide difference in what can happen. With an initial amount of $10,000, an investor could have either been ahead by over $3000 using lump sum or be ahead by over $3000 using DCA. A very wide difference! For full size image, click on the chart.

Image
Source: http://www.bobsfinancialwebsite.com/dow ... LSminusDCA
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: When experts disagree.

Post by Taylor Larimore » Sat Dec 03, 2011 12:28 pm

Hi Bob:
When experts disagree, it often means it doesn't make much difference.

Best wishes.
Taylor
Your chart above proves my point. Lump sum won only 6.2% of the time. :wink:

Best wishes.
Taylor
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Re: When experts disagree.

Post by umfundi » Sat Dec 03, 2011 12:56 pm

Taylor Larimore wrote:Bogleheads:
When experts disagree, it often means it doesn't make much difference.
Best wishes.
Taylor
Taylor, I'm not an expert, but I disagree with your statement. It is easy to find two experts who disagree on active vs. passive management, and it makes a huge difference.

The problem I have with DCA is that it runs counter to the whole philosophy of what I am trying to do. In short, it screws with your asset allocation, which I believe should be sacred.

There are many implications of DCA that others have pointed out. Not the least of these is that the risk it purports to mitigate is unimportant.

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Re: When experts disagree.

Post by Derek Tinnin » Sat Dec 03, 2011 2:18 pm

bob90245 wrote:
Taylor Larimore wrote:Bogleheads:

When experts disagree, it often means it doesn't make much difference.

Best wishes.
Taylor
Taking a look at lump sum versus DCA since January 2000, we see that there is wide difference in what can happen. With an initial amount of $10,000, an investor could have either been ahead by over $3000 using lump sum or be ahead by over $3000 using DCA. A very wide difference! For full size image, click on the chart.

Image
Source: http://www.bobsfinancialwebsite.com/dow ... LSminusDCA
The above is data mining, but even if it's a coin flip between Lump Sum and DCA, why not jump right in once you have a reasonable plan in place and you understand how risk tends to work? Rip that bandaid off instead of removing one hair at a time lol.

OK, I'll do my own data mining. Take the previous 50 years and Lump Sum was best over 70% of the time. Does that matter? I assume this also completely ignores rebalancing a stock/bond mix and ignores global diversification, which are both very relevant and likely makes it even more to the favor of Lump Sum.

That's not the point though, even if DCA is expected to underperform logically or has been proven to underperform most of the time over longer time frames. The point is that it is simply bad advice to encourage or condone mental accounting. Bad behavior is bad behavior.

At the risk of beating a dead horse, it's the advisor who often has the behavior problem, imposing his our own fears onto clients, not giving those clients enough credit for their ability to jump right in based on a good plan. Most have a healthy attitude when decision time comes if you give them a chance to think about it in a responsible manner, but the advisor playing the CYA game creates doubt.

That's my final 2 cents.
Best, DT

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Re: Rick's Rules for Lump Sum Investing

Post by bertilak » Sat Dec 03, 2011 2:38 pm

Ya gotta be in it to win it and the more time spent DCA-ing the less time you are "in it".

BUT, I think we are talking really small potatoes here. In the long run, DCA-ing a pile of money over 2, 4, 6, even 12 months probably won't cost you much. But note that there IS an expected cost based on being partially out of the market. The adviser could point out to the client that once the DCA period is over the client is in about the same position as if he were to have put the money under his mattress for that period and THEN did a lump sum investment -- so why not simply do it now?

I think an adviser should try to enlighten clients, but IF after that the client is STILL wary (doesn't "get it") and wants some sort of placebo THEN it is OK for the adviser to say "Go ahead, DCA. Even though the odds are that this will turn out to be sub-optimal it's not by much and we can simply put that behind us and go on." I do think the adviser owes the client the time to go over this and the respect that the client can learn something. It may lead to a better understanding and better decisions in the future.

If the adviser doesn't make the attempt and the client someday figures it out on his own (or reads Boggleheads.org!) the client may become suspicious that the adviser isn't giving the best advice.
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Re: Rick's Rules for Lump Sum Investing

Post by 555 » Sat Dec 03, 2011 3:27 pm

All this stuff about Lump Sum vs DCA is completely missing the point (and there's been plenty of threads about that already).

The real point is that `investing', generally in liquid assets such as stocks and bonds, is only one part of your overall financial picture. There are other large parts, housing being the obvious one. You have various income and expenses, that can be of all different sizes, predictable or unpredictable, compulsory or discretionary, appearing with various frequencies. You can have illiquid assets of unknown value that may be a source of a windfall of unknown size and timing.

You may or may not know in advance if/when/how much a winfall is coming. But even if you can make plans for it, you can't automatically assume the windfall is to be earmarked for `investing'; there are other options, there can be tax implications. There are decisions that go beyond the simple matter of asset allocation.

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Re: When experts disagree.

Post by bob90245 » Sat Dec 03, 2011 3:32 pm

Derek Tinnin wrote:The above is data mining...
Not really. Just pointing out that over intermediate periods, it may not be a slam dunk in favor of lump sum. But we are really repeating ourselves. All this has been argued in the previous thread someone linked upthread.
Derek Tinnin wrote:... but even if it's a coin flip between Lump Sum and DCA, why not jump right in once you have a reasonable plan in place and you understand how risk tends to work?
Do what ever you want. It's your money.

And to everyone reading this thread, that is my advice. My contribution here is to add another voice to balance out those who say psychology has no place in investing decisions.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by LadyGeek » Sat Dec 03, 2011 4:24 pm

I added this thread to the wiki: Dollar cost averaging

(Also, the 11 page Finally! Can we lay DCA to rest and ban this topic forever? mentioned by tadamsmar.)
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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Sun Dec 04, 2011 3:35 am

tadamsmar wrote:
bertilak wrote:Personally, I would hate to have an adviser tell me what to do based on what he thought would make me feel comfortable. I would expect an adviser to tell me what's best. I can get feel-good advice for free from lots of places.

If I need education, then give me that, not a sugar pill.
Different advisors/writers handle this differently.

Swerdroe tells what is best, while granting that it's better to use DCA than to be too scared to invest at all. Malkiel, Bogle, Ferri offer the sugar pill.

One drawback to the sugar pill approach is that it leaves the impression that the guru is ignorant of the findings of standard finance. Constantinides debunked DCA in 1979, and since then its been part of behavorial investing, investment gurus should know that. Malkiel does make a brief mention that some think DCA is a money loser.
I am arguably falsely putting Malkiel in the sugar pill category. I just noticed that he advocated DCA with "the accretion of yearly savings", the good kind of DCA. BUT his examples seem to imply using it for lump sum investing as well. Read for yourself if you are interested:

http://books.google.com/books?id=O8x1Yp ... &q&f=false

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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Sun Dec 04, 2011 4:07 am

tadamsmar wrote:
tadamsmar wrote:
bertilak wrote:Personally, I would hate to have an adviser tell me what to do based on what he thought would make me feel comfortable. I would expect an adviser to tell me what's best. I can get feel-good advice for free from lots of places.

If I need education, then give me that, not a sugar pill.
Different advisors/writers handle this differently.

Swerdroe tells what is best, while granting that it's better to use DCA than to be too scared to invest at all. Malkiel, Bogle, Ferri offer the sugar pill.

One drawback to the sugar pill approach is that it leaves the impression that the guru is ignorant of the findings of standard finance. Constantinides debunked DCA in 1979, and since then its been part of behavorial investing, investment gurus should know that. Malkiel does make a brief mention that some think DCA is a money loser.
I am arguably falsely putting Malkiel in the sugar pill category. I just noticed that he advocated DCA with "the accretion of yearly savings", the good kind of DCA. BUT his examples seem to imply using it for lump sum investing as well. Read for yourself if you are interested:

http://books.google.com/books?id=O8x1Yp ... &q&f=false
My copy, the fourth edition of "Random Walk" (1984) says nothing about DCA. Malkiel should have rested on his substantial laurels or, at least, have written new books rather than update his classic original work.

Yes, many authors speak about DCA and systematic investing (by payroll deduction) in the same breath.

I was struck by this:
Risk-averse investors who prefer dollar-averaging can accomplish the aim of risk reduction more effectively by lowering the fraction of funds invested in the risky asset and investing them all at once (Rozeff, 1994).
http://www.valueaveraging.ca/docs/DCA%2 ... 0Study.pdf

The issue is not nearly as innocuous as your term "sugar pill" implies. The implications of a DCA philosophy are, I believe, extremely hazardous to your long-term plan. In particular:
You can lower your risk by not investing.
Uninvested cash is risk-free.


I could go on ...

Keith
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Re: Rick's Rules for Lump Sum Investing

Post by 555 » Sun Dec 04, 2011 10:15 am

If you get a lump sum, why should you invest it? Maybe you should pay off your mortgage, or other debt. Maybe you should get your leaking roof fixed Etc. Focusing just on investing is too narrow. It's just one part of your overall financial picture.

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Re: Rick's Rules for Lump Sum Investing

Post by Lbill » Sun Dec 04, 2011 10:20 am

Was there ever a financial adviser who advised a client not to DCA? Even though there's not a shred of credible evidence that DCA works, if I were a financial adviser you can bet that I'd recommend it too. Why take the chance that the client takes a hit right after lump-summing and fires me? Plus the client will never know if DCA-ing actually cost him money, because nobody will ever do a look-back. No-brainer for the FA.
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Re: Rick's Rules for Lump Sum Investing

Post by brick-house » Sun Dec 04, 2011 1:04 pm

Lbill wrote:
Was there ever a financial adviser who advised a client not to DCA? Even though there's not a shred of credible evidence that DCA works, if I were a financial adviser you can bet that I'd recommend it too. Why take the chance that the client takes a hit right after lump-summing and fires me? Plus the client will never know if DCA-ing actually cost him money, because nobody will ever do a look-back. No-brainer for the FA.
I would think most FAs would suggest lump sum. Most FAs (not all) are glorified sales associates who have a quota and get paid on commission or % of assets under management, thus they would want the money invested in the fee based product ASAP. Expected return is the sales narrative for getting the money invested immediately regardless of the client's tolerance for an immediate large drop with a large windfall. I would bet many FAs would also suggest taking a mortgage at today's low interest rates and investing the assets in a fee based stock/bond allocation immediately.
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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Sun Dec 04, 2011 1:29 pm

Lbill wrote:Was there ever a financial adviser who advised a client not to DCA?
Mine, for one. And, for the right reasons. (Yes, some of my savings are managed by a paid professional FA.)

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Sun Dec 04, 2011 2:42 pm

555 wrote:If you get a lump sum, why should you invest it? Maybe you should pay off your mortgage, or other debt. Maybe you should get your leaking roof fixed Etc. Focusing just on investing is too narrow. It's just one part of your overall financial picture.
Of course. We are only talking about investing what can be or should be invested. These types of items should be addressed in the financial plan, and it's OK to spend part of it or give part of it away. Just don't give it away to the hidden cost of DCA. :)

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Re: Rick's Rules for Lump Sum Investing

Post by iceport » Sun Dec 04, 2011 3:16 pm

Lbill wrote:...there's not a shred of credible evidence that DCA works...
Lbill, are you sure about that? Math professor Bill Jones' article, Do Not Dollar-Cost-Average for More than Twelve Months, reproduced on Bill Bernstein's Efficient Frontier website, provides evidence of DCA's effectiveness in mitigating the short term risks of significant loss that lump summing poses. (Note, this is not aimed at long term risk that is properly addressed with an appropriate AA.) If you deem the cost of that short term risk mitigation ("insurance", as Jones terms it) too great, fine. That's certainly arguable. But please don't deny the fact that DCA does mitigate risk.

By the way, Larry Swedroe agrees with this, as he explained in your thread. If your goal is to maximize expected return over the short term, say 1 year, DCA is not for you. Similarly, if your goal is to maximize expected return over the long term, say 30 years, fixed income is not for you.

Some people are willing to trade some expected return for lower risk. In fact, I am one of those people. I am currently targeting a fixed income allocation of ~35%. :oops: I know it makes no sense, that my expected return would be significantly greater if it were 0%, but I find comfort in having a less volatile portfolio. Yes, it's just a psychological crutch, but please don't criticize me for it.

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Credible Evidence

Post by Taylor Larimore » Sun Dec 04, 2011 3:31 pm

...there's not a shred of credible evidence that DCA works...
Hi Lbill:

If you look at Bob's beautiful graph above, and cut off the last year, you will see that DCA worked much better than a lump-sum investment.

I'm not saying that DCA is better--but sometimes it can be for reasons of risk, period return, and emotional comfort.

There is more than one road to Dublin.

Best wishes.
Taylor
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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Sun Dec 04, 2011 4:14 pm

evidence of DCA's effectiveness in mitigating the short term risks of significant loss that lump summing poses.
Really? How big are the "short term risks of significant loss that lump summing poses"?*

That's the problem. DCA is supposed to quell some monster under your bed that doesn't exist.

DCA does not solve the problem you think it does. It is a loser two times out of three. It is completely inconsistent with the philosophy of creating an investment policy, and an asset allocation, and staying the course. And, that the reason to do this is to try to remove emotion and psychology from interfering with a rational plan.

How often do we have to plow this field?

Keith

* Where is the data that shows the "risks of significant loss that lump summing poses"? The question is not that you can show that one strategy is "better" than the other over a carefully selected period.
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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Sun Dec 04, 2011 4:17 pm

Just so there is no more claim of data mining, I have this chart going back to 1900. Sometimes lump sum works, sometimes DCA works. :D
For full size, click on image.

Image
Source: http://www.bobsfinancialwebsite.com/dow ... LSminusDCA
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Re: Rick's Rules for Lump Sum Investing

Post by 555 » Sun Dec 04, 2011 4:31 pm

Derek Tinnin wrote:
555 wrote:If you get a lump sum, why should you invest it? Maybe you should pay off your mortgage, or other debt. Maybe you should get your leaking roof fixed Etc. Focusing just on investing is too narrow. It's just one part of your overall financial picture.
Of course. We are only talking about investing what can be or should be invested. These types of items should be addressed in the financial plan, and it's OK to spend part of it or give part of it away. Just don't give it away to the hidden cost of DCA. :)
Yes but the whole Lump v DCA issue is really not much of an issue. It's really just a Risk v Reward decision. Big whoop.

It's the overall financial plan that is the real issue.

Also, if you get a lump sum, you can't just dump it all in your 401k or IRA even if you wanted to, so the idea that you can just invest it where you want all at once is just plain silly.

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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Sun Dec 04, 2011 4:54 pm

bob90245 wrote:Just so there is no more claim of data mining, I have this chart going back to 1900. Sometimes lump sum works, sometimes DCA works. :D
For full size, click on image.

Image
Source: http://www.bobsfinancialwebsite.com/dow ... LSminusDCA
Bob,

With all due respect, that is the wrong chart.

The chart I'd like to see is, given an LS or a DCA strategy for an initial investment, what is the final result twenty or thirty years later?

On the X-axis: Start month for a $12,000 investment.

The strategies: LS $12,000 on day 1, or DCA $1,000 per month for 12 months. What is the end result after 20 years?

On the Y-axis: Ratio of (DCA result)/(LSI result) at the 20-year point. The deviations above and below 1.0 should be very interesting.

I think such a chart will really help us to understand which dragons a DCA strategy actually slays.

Keith
Déjà Vu is not a prediction

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Re: Rick's Rules for Lump Sum Investing

Post by A Devout Indexer » Sun Dec 04, 2011 5:21 pm

bob90245 wrote:
Derek Tinnin wrote:... but we make decisions based on expected.
I don't agree. Investors make decisions based on psychology. It is the dominant consideration once it is established that there is the need and the ability to invest. On the other hand, if investors made decisions base only on expected, then everyone's portfolio would contain no bonds -- it has lower expected returns.

Taking this line of reasoning to it's logical conclusion, then investors should load up on only those asset classes with the highest expected return: small-cap value, emerging market stocks and the like. Maybe even leverage up.

Unfortunately, we know this doesn't work. We are lucky to have Long Term Capital Management and Lehman Brothers to use as cautionary examples.
Bob,

This is the most dangerous advice I've seen you submit, and I respect you're views. Investors should never intentionally make decisions based on emotion--at that point we are speculating and not investing.

1. The idea is to develop a portfolio with expected returns that are enough to reach one goals with the least risk. Properly done, that includes some combo of stocks/bonds, US/foreign, and large/small & growth/value, etc..

2. Now, either (a) your newfound capital was expected and you have already accounted for it in devising your asset allocation, or (b) it was "found money" which allows you to lower risk to reach the same goals or increase your goals for the same level of risk.

3. If one decides to sit in cash and parcel out their money over a period of weeks, months, or quarters, they are betting on the fact that over this period of time, cash offers a better opportunity to reach one's goals. In essence, you are guessing you can predict when the markets have underpriced risk relative to expected returns. This, pure and simple, is speculation. To take this to the logical extreme, if we ignore taxes and transaction fees, one should periodically adjust their portfolio between their IPS AA and cash based on when markets failure to properly price risk/return. Obviously this makes no sense.

Of course, if one simply cannot bring themselves to "plunge in", then "wadding in" over the shortest period possible is the next best option. However, 2 caveats apply:
i. you will probably opt to DCA when perception of risk/expected returns is highest, costing you the most
ii. If you are uncomfortable investing new $ at your chosen AA, questions around existing $s are probably next, so it might make sense to revisit your AA

Finally, on the topic of which option (DCA vs Lump Sum) makes the most sense on paper from a ris/return standpoint on mult-asset class portfolios, everyone should google: "To Wade or Plunge" by Truman Clark. The best piece (by far) I have seen on the topic.
Last edited by A Devout Indexer on Sun Dec 04, 2011 5:35 pm, edited 2 times in total.

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Re: Rick's Rules for Lump Sum Investing

Post by A Devout Indexer » Sun Dec 04, 2011 5:25 pm

Keith: the answer you are looking for resides in the paper I referenced. Note that when you say "what works best over 20/30 years", the answer is "what works best over the DCA period if we assume $ is invested the same after the DCA period regardless of the initial path chosen.

The evidence finds that DCA costs investors 3% to 5% per year. Clearly a costly decision.

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Sun Dec 04, 2011 5:25 pm

umfundi wrote:Bob,

With all due respect, that is the wrong chart.

The chart I'd like to see is, given an LS or a DCA strategy for an initial investment, what is the final result twenty or thirty years later?

On the X-axis: Start month for a $12,000 investment.

The strategies: LS $12,000 on day 1, or DCA $1,000 per month for 12 months. What is the end result after 20 years?

On the Y-axis: Ratio of (DCA result)/(LSI result) at the 20-year point. The deviations above and below 1.0 should be very interesting.

I think such a chart will really help us to understand which dragons a DCA strategy actually slays.

Keith
I understand what you want to see. I'll have to think how this can done.

Then again, it seems that the chart makes the result intuitive. One of three can occur:
  • Lump sum has a wide lead (say more than 15%)

    Neither lump sum or DCA leads by much (less than 15%)

    DCA has a wide lead (say more than 15%)
Eyeballing the chart, the latter category occurred in the minority of the time.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Sun Dec 04, 2011 5:40 pm

A Devout Indexer wrote:
bob90245 wrote:
Derek Tinnin wrote:... but we make decisions based on expected.
I don't agree. Investors make decisions based on psychology. It is the dominant consideration once it is established that there is the need and the ability to invest. On the other hand, if investors made decisions base only on expected, then everyone's portfolio would contain no bonds -- it has lower expected returns.

Taking this line of reasoning to it's logical conclusion, then investors should load up on only those asset classes with the highest expected return: small-cap value, emerging market stocks and the like. Maybe even leverage up.

Unfortunately, we know this doesn't work. We are lucky to have Long Term Capital Management and Lehman Brothers to use as cautionary examples.
Bob,

This is the most dangerous advice I've seen you submit, and I respect you're views. Investors should never intentionally make decisions based on emotion--at that point we are speculating and not investing.
You clearly missed my point. Investors are human. They cannot turn off emotions like a light switch. A field of Behavioral Finance has done extensive research in this area.

The correct approach is not to ignore emotions and brute force a decision. That will be a disaster waiting to happen. Rather, the better approach is to acknowledge emotions and incorporate that in the decision making process and thus minimize adverse outcomes. You don't want to have investors exceed their unique willingness to handle market volatility both in the near term (lump sum versus DCA) and in the long term (their equity-fixed split).
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by A Devout Indexer » Sun Dec 04, 2011 5:46 pm

bob90245 wrote:
A Devout Indexer wrote:
bob90245 wrote:
Derek Tinnin wrote:... but we make decisions based on expected.
I don't agree. Investors make decisions based on psychology. It is the dominant consideration once it is established that there is the need and the ability to invest. On the other hand, if investors made decisions base only on expected, then everyone's portfolio would contain no bonds -- it has lower expected returns.

Taking this line of reasoning to it's logical conclusion, then investors should load up on only those asset classes with the highest expected return: small-cap value, emerging market stocks and the like. Maybe even leverage up.

Unfortunately, we know this doesn't work. We are lucky to have Long Term Capital Management and Lehman Brothers to use as cautionary examples.
Bob,

This is the most dangerous advice I've seen you submit, and I respect you're views. Investors should never intentionally make decisions based on emotion--at that point we are speculating and not investing.
You clearly missed my point. Investors are human. They cannot turn off emotions like a light switch. A field of Behavioral Finance has done extensive research in this area.

The correct approach is not to ignore emotions and brute force a decision. That will be a disaster waiting to happen. Rather, the better approach is to acknowledge emotions and incorporate that in the decision making process and thus minimize adverse outcomes. You don't want to have investors exceed their unique willingness to handle market volatility both in the near term (lump sum versus DCA) and in the long term (their equity-fixed split).

OK, I understand a bit better. But I think you might be selling some/most investors short? I mean, Bogleheads are adamant in their belief that most investors don't buy high/sell low, and just about everyone can maintain a reasonable allocation uninterrupted through thick and thin.

I of course agree with you, Bernstein, et. all on this that only a handful of really disciplined and patient investors are up to the challenge . But where does the advice adjustment from what's "optimal" to what's "doable" end? Should investors incorporate acceptable active management or tactical shifts into their IPS because they are "human" and likely to be overwhelmed by those urges now and again? It's a slippery slope I think...

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Re: Rick's Rules for Lump Sum Investing

Post by iceport » Sun Dec 04, 2011 5:52 pm

umfundi wrote:
evidence of DCA's effectiveness in mitigating the short term risks of significant loss that lump summing poses.
Really? How big are the "short term risks of significant loss that lump summing poses"?*

That's the problem. DCA is supposed to quell some monster under your bed that doesn't exist.

DCA does not solve the problem you think it does. It is a loser two times out of three. It is completely inconsistent with the philosophy of creating an investment policy, and an asset allocation, and staying the course. And, that the reason to do this is to try to remove emotion and psychology from interfering with a rational plan.

How often do we have to plow this field?

Keith

* Where is the data that shows the "risks of significant loss that lump summing poses"? The question is not that you can show that one strategy is "better" than the other over a carefully selected period.
Keith,

The article hardly attempts to show that DCA is a "better" strategy. It simply attempts to compare the risk/return relationship between DCA over 6-, 12-, 18-, and 36-month periods and lump sum investing. And using all rolling periods from 1953 to 1996 hardly strikes me as a carefully selected period. Jones looks at the relative protection and the relative cost of DCA in a balanced way. Thought he indicates his opinion of the results of his analysis, his summary is intended to provide some form of quantitative basis for using DCA at all, and if so, over what period. It's akin to the risk/return summaries mutual fund companies and advisors use to help people settle on an equity/fixed income allocation. And just like the choice of AA, it all comes down to each individual squinting at the data, grossly assessing their ability and willingness to sustain loss -- and need to take risk -- and taking a crude stab at an appropriate decision. There is no precise or sophisticated means to determine if DCA is appropriate, just as there is no precise or sophisticated means to determine if your AA is appropriate.

Your reply almost indicates that you did not read the linked article.

--Pete
"Discipline matters more than allocation.” ─William Bernstein

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Sun Dec 04, 2011 5:54 pm

555 wrote:
Derek Tinnin wrote:
555 wrote:If you get a lump sum, why should you invest it? Maybe you should pay off your mortgage, or other debt. Maybe you should get your leaking roof fixed Etc. Focusing just on investing is too narrow. It's just one part of your overall financial picture.
Of course. We are only talking about investing what can be or should be invested. These types of items should be addressed in the financial plan, and it's OK to spend part of it or give part of it away. Just don't give it away to the hidden cost of DCA. :)
Yes but the whole Lump v DCA issue is really not much of an issue. It's really just a Risk v Reward decision. Big whoop.

It's the overall financial plan that is the real issue.

Also, if you get a lump sum, you can't just dump it all in your 401k or IRA even if you wanted to, so the idea that you can just invest it where you want all at once is just plain silly.
Where are you coming up with this stuff? Have we not repeated over and over that you invest ACCORDING TO A PLAN?

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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Sun Dec 04, 2011 5:56 pm

bob90245 wrote:
umfundi wrote:Bob,

With all due respect, that is the wrong chart.

The chart I'd like to see is, given an LS or a DCA strategy for an initial investment, what is the final result twenty or thirty years later?

On the X-axis: Start month for a $12,000 investment.

The strategies: LS $12,000 on day 1, or DCA $1,000 per month for 12 months. What is the end result after 20 years?

On the Y-axis: Ratio of (DCA result)/(LSI result) at the 20-year point. The deviations above and below 1.0 should be very interesting.

I think such a chart will really help us to understand which dragons a DCA strategy actually slays.

Keith
I understand what you want to see. I'll have to think how this can done.

Then again, it seems that the chart makes the result intuitive. One of three can occur:
  • Lump sum has a wide lead (say more than 15%)

    Neither lump sum or DCA leads by much (less than 15%)

    DCA has a wide lead (say more than 15%)
Eyeballing the chart, the latter category occurred in the minority of the time.
Bob,

Thank you. I am a scientist / engineer, and a devout believer in the Scientific Method. That says, if you have an hypothesis for a method, you should also have a theory to test it against.

My guess is that the chart will show:

1. LS beats DCA right after the initial 12-month period 2/3 of the time, by some not large fraction of the initial investment. After 20 years, those differences are very much magnified in dollar amounts, though the percentage difference is the same.

2. There are (some, none, a few) points where the ratio of the DCA to LSI result is much greater than 1.0. For the last 50 years, how many points are there out of the 50*12 = 600 months that have a ratio greater than, say, 2.0? Or 1.5, or whatever.

My theory is that backtesting will show that the monster under your bed shows up infrequently enough that you should not worry about it day-to-day.

kEITH
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Re: Rick's Rules for Lump Sum Investing

Post by umfundi » Sun Dec 04, 2011 6:19 pm

petrico wrote:
umfundi wrote:
evidence of DCA's effectiveness in mitigating the short term risks of significant loss that lump summing poses.
Really? How big are the "short term risks of significant loss that lump summing poses"?*

That's the problem. DCA is supposed to quell some monster under your bed that doesn't exist.

DCA does not solve the problem you think it does. It is a loser two times out of three. It is completely inconsistent with the philosophy of creating an investment policy, and an asset allocation, and staying the course. And, that the reason to do this is to try to remove emotion and psychology from interfering with a rational plan.

How often do we have to plow this field?

Keith

* Where is the data that shows the "risks of significant loss that lump summing poses"? The question is not that you can show that one strategy is "better" than the other over a carefully selected period.
Keith,

The article hardly attempts to show that DCA is a "better" strategy. It simply attempts to compare the risk/return relationship between DCA over 6-, 12-, 18-, and 36-month periods and lump sum investing. And using all rolling periods from 1953 to 1996 hardly strikes me as a carefully selected period. Jones looks at the relative protection and the relative cost of DCA in a balanced way. Thought he indicates his opinion of the results of his analysis, his summary is intended to provide some form of quantitative basis for using DCA at all, and if so, over what period. It's akin to the risk/return summaries mutual fund companies and advisors use to help people settle on an equity/fixed income allocation. And just like the choice of AA, it all comes down to each individual squinting at the data, grossly assessing their ability and willingness to sustain loss -- and need to take risk -- and taking a crude stab at an appropriate decision. There is no precise or sophisticated means to determine if DCA is appropriate, just as there is no precise or sophisticated means to determine if your AA is appropriate.

Your reply almost indicates that you did not read the linked article.

--Pete
Pete,

The message I was reacting to was about the:
"short term risks of significant loss that lump summing poses"?
I am well aware of studies that show DCA is almost only slightly worse than something else you might do, and besides it might lessen your anxiety.

I am looking for a credible source of the statement that justifies the assertion of the "short term risks of significant loss that lump summing poses"

And yes, I have not yet read the reference you cite.

Keith
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Re: Rick's Rules for Lump Sum Investing

Post by bob90245 » Sun Dec 04, 2011 6:29 pm

A Devout Indexer wrote:OK, I understand a bit better. But I think you might be selling some/most investors short? I mean, Bogleheads are adamant in their belief that most investors don't buy high/sell low, and just about everyone can maintain a reasonable allocation uninterrupted through thick and thin.

I of course agree with you, Bernstein, et. all on this that only a handful of really disciplined and patient investors are up to the challenge . But where does the advice adjustment from what's "optimal" to what's "doable" end? Should investors incorporate acceptable active management or tactical shifts into their IPS because they are "human" and likely to be overwhelmed by those urges now and again? It's a slippery slope I think...
That's an interesting extrapolation. Maybe Bill Bernstein has thought about it. :wink:

Given all the research on the subject, active management is probably easy to show how it might not be all its cracked up to be. As to tactical shifts, you might have more difficulty. I do see posters here talk about it as something they plan on doing. Usually in the context of valuations, P/E10, etc. And don't forget in his books, Jack Bogle has written about using tactical shifts in a judicious manner (i.e. plus or minus 15%).
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Rick's Rules for Lump Sum Investing

Post by 555 » Sun Dec 04, 2011 7:29 pm

Derek Tinnin wrote:
555 wrote:
Derek Tinnin wrote:
555 wrote:If you get a lump sum, why should you invest it? Maybe you should pay off your mortgage, or other debt. Maybe you should get your leaking roof fixed Etc. Focusing just on investing is too narrow. It's just one part of your overall financial picture.
Of course. We are only talking about investing what can be or should be invested. These types of items should be addressed in the financial plan, and it's OK to spend part of it or give part of it away. Just don't give it away to the hidden cost of DCA. :)
Yes but the whole Lump v DCA issue is really not much of an issue. It's really just a Risk v Reward decision. Big whoop.

It's the overall financial plan that is the real issue.

Also, if you get a lump sum, you can't just dump it all in your 401k or IRA even if you wanted to, so the idea that you can just invest it where you want all at once is just plain silly.
Where are you coming up with this stuff? Have we not repeated over and over that you invest ACCORDING TO A PLAN?
Non sequitur. If you've got something to say that is related to my comment, I'd be glad to hear it.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Mon Dec 05, 2011 7:38 am

555 wrote:
Derek Tinnin wrote:
555 wrote:
Derek Tinnin wrote:
555 wrote:If you get a lump sum, why should you invest it? Maybe you should pay off your mortgage, or other debt. Maybe you should get your leaking roof fixed Etc. Focusing just on investing is too narrow. It's just one part of your overall financial picture.
Of course. We are only talking about investing what can be or should be invested. These types of items should be addressed in the financial plan, and it's OK to spend part of it or give part of it away. Just don't give it away to the hidden cost of DCA. :)
Yes but the whole Lump v DCA issue is really not much of an issue. It's really just a Risk v Reward decision. Big whoop.

It's the overall financial plan that is the real issue.

Also, if you get a lump sum, you can't just dump it all in your 401k or IRA even if you wanted to, so the idea that you can just invest it where you want all at once is just plain silly.
Where are you coming up with this stuff? Have we not repeated over and over that you invest ACCORDING TO A PLAN?
Non sequitur. If you've got something to say that is related to my comment, I'd be glad to hear it.
The idea of investing it WHERE you want is irrelevent to this thread, and overstates the obvious anyway. We are talking about WHEN to invest once you know WHERE you CAN invest.

Yes, IRAs/401(k)s and the like have limits. That's quite obvious. We deal with it and move on to taxable accounts which do not have limits. So yes, you CAN in fact invest in LS fashion according to an asset LOCATION plan (maximize contributions to preferred locations first), which is a subset of the ALLOCATION plan.

So the "idea that you can just invest WHERE you WANT all at once" being plain silly is kind of silly to bring up in the first place. The idea that you CAN invest WHEN you want is not silly at all - you can invest SOMEWHERE according to the well-known rules associated with various types of accounts. Can we not be more clear on this?

I have handled hundreds of situations invlolving LS vs. DCA and asset location has never been the deciding factor of whether to LS or DCA. Am I still missing something? Help me out if so...

Regards, DT

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Mon Dec 05, 2011 9:14 am

umfundi wrote: Pete,

The message I was reacting to was about the:
"short term risks of significant loss that lump summing poses"?
I am well aware of studies that show DCA is almost only slightly worse than something else you might do, and besides it might lessen your anxiety.

I am looking for a credible source of the statement that justifies the assertion of the "short term risks of significant loss that lump summing poses"

And yes, I have not yet read the reference you cite.

Keith
Keith: Of course, LS puts one at a short-term risk of significant loss. The market might crash 90% the day after you did it. It's happen before. If are are truly think LS relies on the premise that there is no risk of a large short-term loss, then you should change sides and advocate DCA.

The argument in favor of LS is that the risk is the same for all dollars in your nest egg. There is no standard financial reason to treat a dollar you invested a year ago differently than a dollar you won the the lottery last week. If holding a big chunk of cash to reduce short-term risk is good for the goose, then it's good for the gander. (BTW, I can cite at least half a dozen Boglehead posts that have made ths goose-gander argument, including at least one other on this thread. It was made in the peer reviewed literature in 1979 and it shut down any further discussion of the idea that DCA could be justified as part of standard finance.)

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Re: Rick's Rules for Lump Sum Investing

Post by bertilak » Mon Dec 05, 2011 9:35 am

tadamsmar wrote:Keith: Of course, LS puts one at a short-term risk of significant loss. The market might crash 90% the day after you did it. It's happen before. If are are truly think LS relies on the premise that there is no risk of a large short-term loss, then you should change sides and advocate DCA.
OR -- the market may wait to crash 90% the day after you finish your DCA program. (If you can propose a crash the day after you start, I instead can propose one the day after you finish!)

With DCA you gain nothing and lose the opportunity to be fully invested, and thereby get the maximum possible dividends and, perhaps, appreciation all along. And, I'd rather weather a 90% crash after my investments have gone up 90%. (If you can propose a hypothetical 90% loss, I can propose a hypothetical 90% gain!)
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet

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Re: Rick's Rules for Lump Sum Investing

Post by ddb » Mon Dec 05, 2011 9:49 am

brick-house wrote:ddb wrote:
Let's say an investor has a lump sum available, with an IPS of 50% stock/50% bond, and they decide to DCA in 3 equal annual deposits starting today. What they are basically saying is this: In year 1, I want an allocation of 16.67/16.67/66.67 stock/bonds/cash. In year 2, I want an allocation of 33.33/33.33/33.33 stock/bonds/cash. In year 3, I want an allocation of 50/50/0 stock/bonds cash. How is it rational in any world to have a target allocation that shifts so dramtically over such a short time period?
If I put a windfall lump sum into the 50 stock/50 bond portfolio in 2007 - then by March 2009, my 50/50 portfolio was 25 stock/75 bond due to the 50-60% downturn in the stock market. A million dollar lump sum into 50/50 would be down $250,000. How is that rational?
Pointing to a worst-case scenario as reasoning for why to DCA does not seem wise. I could likewise point out certain time periods where DCA failed spectacularly compared to lump sum.

Look above at my example of two near-identical investors. If DCA is appropriate, then everybody who is fully invested now should sell out and DCA back in. Now you tell me - is THAT rational?

- DDB
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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Mon Dec 05, 2011 9:55 am

tadamsmar wrote:If holding a big chunk of cash to reduce short-term risk is good for the goose, then it's good for the gander.
Wrong, holding a "big chunk of cash" to reduce short-term risk is part of your allocation plan. Invest according to the plan, which considers both short-term and long-term risk.

The DCA version of reducing short-term risk is in no way related to the tenets of passive investing. It simply cannot be any other way. To recommend DCA is to recommend something other than passive investing, and that something is in some way related to mental accounting, market timing, distrust of the market's ability to price risk in a fair fashion, or a fear-driven approach to investing because you do not have a good idea of the amount and types of risk that are appropriate for you.

If you fear short-term price fluctuations, take care of that in your stock/bond mix up front. Don't tiptoe around it with DCA.

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Re: When experts disagree.

Post by ddb » Mon Dec 05, 2011 10:04 am

Taylor Larimore wrote:Bogleheads:

When experts disagree, it often means it doesn't make much difference.

Best wishes.
Taylor
????

Lots of experts espouse active management and market-timing, while others advocate for passive management and stay-the-course. Does this issue "matter"?

Lots of experts think the world is a few thousand years old and that judgment day is coming. Others think that defending their religion at all costs ensures a gaggle of virgins in the afterlife. Others think the world is billions of years old and that modern life is a function of the evolutionary process. Does this issue "matter"?
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB

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Re: Rick's Rules for Lump Sum Investing

Post by tadamsmar » Mon Dec 05, 2011 10:17 am

Derek Tinnin wrote:
tadamsmar wrote:If holding a big chunk of cash to reduce short-term risk is good for the goose, then it's good for the gander.
Wrong, holding a "big chunk of cash" to reduce short-term risk is part of your allocation plan. Invest according to the plan, which considers both short-term and long-term risk.

The DCA version of reducing short-term risk is in no way related to the tenets of passive investing. It simply cannot be any other way. To recommend DCA is to recommend something other than passive investing, and that something is in some way related to mental accounting, market timing, distrust of the market's ability to price risk in a fair fashion, or a fear-driven approach to investing because you do not have a good idea of the amount and types of risk that are appropriate for you.

If you fear short-term price fluctuations, take care of that in your stock/bond mix up front. Don't tiptoe around it with DCA.
I can't figure out what your post has to do with my statement. You must have read something into it that I did not intend.

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Re: Rick's Rules for Lump Sum Investing

Post by Derek Tinnin » Mon Dec 05, 2011 10:49 am

tadamsmar wrote:
Derek Tinnin wrote:
tadamsmar wrote:If holding a big chunk of cash to reduce short-term risk is good for the goose, then it's good for the gander.
Wrong, holding a "big chunk of cash" to reduce short-term risk is part of your allocation plan. Invest according to the plan, which considers both short-term and long-term risk.

The DCA version of reducing short-term risk is in no way related to the tenets of passive investing. It simply cannot be any other way. To recommend DCA is to recommend something other than passive investing, and that something is in some way related to mental accounting, market timing, distrust of the market's ability to price risk in a fair fashion, or a fear-driven approach to investing because you do not have a good idea of the amount and types of risk that are appropriate for you.

If you fear short-term price fluctuations, take care of that in your stock/bond mix up front. Don't tiptoe around it with DCA.
I can't figure out what your post has to do with my statement. You must have read something into it that I did not intend.
Sorry if I didn't understand...I was assuming that you were implying that DCA somehow reduces short term risk that LS cannot.

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