I always thought that dollar-cost averaging was stupid

[StageLeft]

Dollar cost averaging says that you invest over time smaller amounts instead of a lump sum infrequently. This is to flatten things out and avoid being burned by going in huge before things go down (bad). Of course, the flip is that you also avoid going in huge before they go up (good). I saw this quote today on yahoo finance:

For investors who've been skeptical of the rally's staying power (like yours truly), Mortimer's advice is simple: dollar-cost average into stocks and use pullbacks to increase equity exposure to levels appropriate to your age and risk tolerance.

But it occurred to me, if this is a good time, according to this guy, to get in the market, why would I wait? Presumably it will be higher in the future than it is now, so why am I holding out? The mathmatical reality is that, say DOW is 8400 today and I invest $1000. Contrast with investing $250 when it's 7900, $250 when it's 8600, $250 when it's 8300, $250 when it's 8200, this is really no different than investing $1000 at 8250, so the difference is if I invest today I know what I put my money in at, but if I dollar cost in I don't really know what the average was until I'm finished. If the market is doing generally up, the longer I wait to get in, the more money I lose.

Don't believe me? Well, this article on money central spells it out and says DCA doesn't work. It is still touted a lot, though. My dad mentioned it to me first years ago and it seemed kind of stupid to me then.

I presume there are some meaningful counterarguments and would like to hear one!

Wikipedia has some damning comments about it, too. I really wonder why people speak of it in such a worshiped way. Wiki's confusion section is very pertinent; it basically says that if you don't have all the up-front money, like most of us, they may call it DCA, but really it's just putting in what you can. If you do have all the money up front, though, you want to put it all in on a market that's likely to go up and not dick around with dca.

 

[nerp]

DCO works out well if you continue to buy through a down market.

I'm not a financial whizz, but I do know that DCO has helped me make a good sum of money in the market since November. Had I just sat on my investments or watched some stocks I was down on just go idle, I'd finally be breaking even now instead of up substantially on everything. I got a LOT of cheap shares for a while there.

For short-term plays, DCO has helped me out a bit too.

 

[Special K]

Originally posted by: Skoorb
Dollar cost averaging says that you invest over time smaller amounts instead of a lump sum infrequently. This is to flatten things out and avoid being burned by going in huge before things go down (bad). Of course, the flip is that you also avoid going in huge before they go up (good). I saw this quote today on yahoo finance:

For investors who've been skeptical of the rally's staying power (like yours truly), Mortimer's advice is simple: dollar-cost average into stocks and use pullbacks to increase equity exposure to levels appropriate to your age and risk tolerance.

But it occurred to me, if this is a good time, according to this guy, to get in the market, why would I wait?

It doesn't sound like he's saying now is a good time to get in - honestly no one knows. He's just saying that if one wants to continue to invest in the stock market but is wary of the recent rally, investing smaller sums over time is a good way to invest more money in the stock market without worrying about suffering the huge loss that would occur if they were to lump-sum everything today and then watch as the market tanks again.

Originally posted by: Skoorb
Presumably it will be higher in the future than it is now, so why am I holding out? The mathmatical reality is that, say DOW is 8400 today and I invest $1000. Contrast with investing $250 when it's 7900, $250 when it's 8600, $250 when it's 8300, $250 when it's 8200, this is really no different than investing $1000 at 8250, so the difference is if I invest today I know what I put my money in at, but if I dollar cost in I don't really know what the average was until I'm finished. If the market is doing generally up, the longer I wait to get in, the more money I lose.

Define "the future". What if we drop back down to the 6XXX range sometime this year? Then you would have been better off waiting until then to invest anything. Also keep in mind windows of opportunity - for most people, the 401k is their primary retirement account. The only way to contribute to a 401k is to have regular installments deducted from each paycheck. You can't go back later and make a lump-sum investment into your 401k. I suppose if your 401k offers a money market fund you could deposit all your contributions to that and then swap out to stocks later, but that again assumes you have some unique insight into which way the market will move.

Originally posted by: Skoorb
Don't believe me? Well, this article on money central spells it out and says DCA doesn't work. It is still touted a lot, though. My dad mentioned it to me first years ago and it seemed kind of stupid to me then.

I presume there are some meaningful counterarguments and would like to hear one!

Wikipedia has some damning comments about it, too. I really wonder why people speak of it in such a worshiped way. Wiki's confusion section is very pertinent; it basically says that if you don't have all the up-front money, like most of us, they may call it DCA, but really it's just putting in what you can. If you do have all the money up front, though, you want to put it all in on a market that's likely to go up and not dick around with dca.

I think the benefits of DCA may be more psychological than anything else. Historically, the market moves up 2/3 of the time, and down 1/3 of the time, so if you evaluate it on strictly that basis, you would be better off lump-sum investing. However, that obviously doesn't mean that you are better off lump-sum investing in any particular scenario.

Ultimately I think you have to ask yourself this question: which would bother you more - investing a lump-sum and watching it promptly tank 20%, or DCA'ing your investment and missing out on some gains because the market rose. Studies in behavioral economics seem to indicate that most people find losses more painful than missed gains, but ultimately that's a personal decision.

Plus as you said, everyone is DCA'ing to some extent, because we receive a regular income stream and invest what we can from it.

 

[StageLeft]

Originally posted by: nerp
DCO works out well if you continue to buy through a down market.

I'm not a financial whizz, but I do know that DCO has helped me make a good sum of money in the market since November. Had I just sat on my investments or watched some stocks I was down on just go idle, I'd finally be breaking even now instead of up substantially on everything. I got a LOT of cheap shares for a while there.

For short-term plays, DCO has helped me out a bit too.

If you are trying to time it and are not going to be able to beat the market, it does force you to buy in even when you don't feel comfortable with it, which is a good idea generally.

 

[UglyCasanova]

If you are looking to reduce risk then there is only one sure fire method, diversification (or just buying treasuries, in which case you make nothing). A well diversified portfolio eliminates any company specific risk and you are left with just the systematic risk of the market. Then hold it for the long run. Investing your money little by little, any gains made would be offset by opportunity cost from the money not invested. If you want to instantly diversify yourself just invest in a mutual fund that follows an index such as S&P. Instant market portfolio. Or you can do fundamental analysis on the stocks to see if they are below or above their intrinsic value in order to tell you to buy or not. Just don't let your money sit idle.

 

[Special K]

Originally posted by: UglyCasanova
If you are looking to reduce risk then there is only one sure fire method, diversification (or just buying treasuries, in which case you make nothing). A well diversified portfolio eliminates any company specific risk and you are left with just the systematic risk of the market. Then hold it for the long run. Investing your money little by little, any gains made would be offset by opportunity cost from the money not invested. If you want to instantly diversify yourself just invest in a mutual fund that follows an index such as S&P. Instant market portfolio. Or you can do fundamental analysis on the stocks to see if they are below or above their intrinsic value in order to tell you to buy or not. Just don't let your money sit idle.

This doesn't really address the issue of DCA vs. lump sum investing though.

 

[Alienwho]

Transaction costs also play a part in dollar-cost accounting. If you're going to be 50 shares of stock every month for six months, you're going to pay the transaction costs 6 times.

 

[vi edit]

The key word here is "average". Your average investor is an idiot. DCA takes the need to research and study technical charts out of the equation.

You simply buy more shares when they are cheap, and less shares when they are expensive.

 

[vi edit]

Originally posted by: Alienwho
Transaction costs also play a part in dollar-cost accounting. If you're going to be 50 shares of stock every month for six months, you're going to pay the transaction costs 6 times.

Most mutual funds can be set up for free recurring buys/transfers.

 

[Special K]

Originally posted by: vi edit
The key word here is "average". Your average investor is an idiot. DCA takes the need to research and study technical charts out of the equation.

You simply buy more shares when they are cheap, and less shares when they are expensive.

Most people would be best served by DCA'ing into low-cost index funds and forgetting about it. You'll outperform the majority of active investors and mutual funds in the long run, and you don't even have to do active research. Every academic study done on market timing indicates that the vast majority of people end up worse off in the long run for having tried it.

 

[racolvin]

For many the largest saving vehicle they have is DCA by default - their 401k. Some portion of their salary gets put in and investments get purchased every pay period and that's DCA whether you want to or not. Oh sure, you could have your funds to into a MMA in your 401k and then handle the actual fund purchases manually but the VAST majority of folks wouldn't do it, nor would they do the research needed.

As for investing with money outside your 401k, I would have to agree, DCA doesn't work as well as the old investment advice would have people believe.

 

[Elbryn]

number 1 goal is saving more. whether you have the ability to do it without automating via dca more power to you. the biggest advantage is the getting rid of money before you see it and can spend it aspect. That alone forces people to save which accomplishes the number 1 goal.

 

[Kntx]

I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

 

[TheoPetro]

Originally posted by: Kntx
I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

The problem is that you dont know which ones are going to fall more. What if I told you that I liked IBM at anything under $95 (which is pretty much accurate). Say tomorrow IBM goes to $94 should I hold out and invest only a percentage of my $ thinking "hey if it goes down more ill DCA" or should I invest 100% of it because I dont know if it will go down or up from there.

DCA is timing the market, in a round a bout way. I personally dont have the expertise or funds to be able to time the market so for me DCA doesnt make much sense.

 

[TallBill]

Originally posted by: Special K

Originally posted by: vi edit
The key word here is "average". Your average investor is an idiot. DCA takes the need to research and study technical charts out of the equation.

You simply buy more shares when they are cheap, and less shares when they are expensive.

Most people would be best served by DCA'ing into low-cost index funds and forgetting about it. You'll outperform the majority of active investors and mutual funds in the long run, and you don't even have to do active research. Every academic study done on market timing indicates that the vast majority of people end up worse off in the long run for having tried it.

Yup, "Bogleheads guide to investing" sums it up well. It's a great read on the subject. It's nearly impossible to beat regularly investments into an index fund. Yet I hear very intelligent friends and family speak about beating them.

 

[vi edit]

Originally posted by: TheoPetro

Originally posted by: Kntx
I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

The problem is that you dont know which ones are going to fall more. What if I told you that I liked IBM at anything under $95 (which is pretty much accurate). Say tomorrow IBM goes to $94 should I hold out and invest only a percentage of my $ thinking "hey if it goes down more ill DCA" or should I invest 100% of it because I dont know if it will go down or up from there.

DCA is timing the market, in a round a bout way. I personally dont have the expertise or funds to be able to time the market so for me DCA doesnt make much sense.

Huh?

DCA is the *ANTI* timing. It removes any and all emotion, planning, or research from the equation. It doesn't care about current stock prices, 52w hi/lows PE ratios, ect. It simply says "Buy $X's worth of shares on X day of the month" for most people who use it (401k/s, IRA's investing in indexes, ect).

 

[TheoPetro]

Originally posted by: vi edit

Originally posted by: TheoPetro

Originally posted by: Kntx
I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

The problem is that you dont know which ones are going to fall more. What if I told you that I liked IBM at anything under $95 (which is pretty much accurate). Say tomorrow IBM goes to $94 should I hold out and invest only a percentage of my $ thinking "hey if it goes down more ill DCA" or should I invest 100% of it because I dont know if it will go down or up from there.

DCA is timing the market, in a round a bout way. I personally dont have the expertise or funds to be able to time the market so for me DCA doesnt make much sense.

Huh?

DCA is the *ANTI* timing. It removes any and all emotion, planning, or research from the equation. It doesn't care about current stock prices, 52w hi/lows PE ratios, ect. It simply says "Buy $X's worth of shares on X day of the month" for most people who use it (401k/s, IRA's investing in indexes, ect).

Im not talking about automatic DCA im talking about an individual investor with X dollars sitting in his trading account making the decision whether or not to DCA when he purchases stock.

I agree that in an automatic (401k) type of deal it does remove the emotion/planning/research. I dont think thats the best way to go about investing (over the company match) but w/e floats your boat.

 

[Special K]

Originally posted by: vi edit

Originally posted by: TheoPetro

Originally posted by: Kntx
I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

The problem is that you dont know which ones are going to fall more. What if I told you that I liked IBM at anything under $95 (which is pretty much accurate). Say tomorrow IBM goes to $94 should I hold out and invest only a percentage of my $ thinking "hey if it goes down more ill DCA" or should I invest 100% of it because I dont know if it will go down or up from there.

DCA is timing the market, in a round a bout way. I personally dont have the expertise or funds to be able to time the market so for me DCA doesnt make much sense.

Huh?

DCA is the *ANTI* timing. It removes any and all emotion, planning, or research from the equation. It doesn't care about current stock prices, 52w hi/lows PE ratios, ect. It simply says "Buy $X's worth of shares on X day of the month" for most people who use it (401k/s, IRA's investing in indexes, ect).

I'm not sure if you are actually speaking out against passive investing here or just telling it like it is, but who honestly has enough time to spend properly researching enough stocks to assemble a portfolio that eliminates as much non-systematic risk as is possible with mutual/index funds?

Consider the fact that there are analysts out there whose full time job is to research a handful of stocks in a particular sector. How can the average person hope to have enough time to properly assemble a portfolio of enough stocks to properly diversify away non-systematic risk?

Either they aren't doing as thorough of an analysis as they should be, or they aren't owning enough stocks to properly diversify.

 

[Elbryn]

Originally posted by: TheoPetro

Originally posted by: vi edit

Originally posted by: TheoPetro

Originally posted by: Kntx
I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

The problem is that you dont know which ones are going to fall more. What if I told you that I liked IBM at anything under $95 (which is pretty much accurate). Say tomorrow IBM goes to $94 should I hold out and invest only a percentage of my $ thinking "hey if it goes down more ill DCA" or should I invest 100% of it because I dont know if it will go down or up from there.

DCA is timing the market, in a round a bout way. I personally dont have the expertise or funds to be able to time the market so for me DCA doesnt make much sense.

Huh?

DCA is the *ANTI* timing. It removes any and all emotion, planning, or research from the equation. It doesn't care about current stock prices, 52w hi/lows PE ratios, ect. It simply says "Buy $X's worth of shares on X day of the month" for most people who use it (401k/s, IRA's investing in indexes, ect).

Im not talking about automatic DCA im talking about an individual investor with X dollars sitting in his trading account making the decision whether or not to DCA when he purchases stock.

I agree that in an automatic (401k) type of deal it does remove the emotion/planning/research. I dont think thats the best way to go about investing (over the company match) but w/e floats your boat.

How is dca with a stock any different than dca with a fund? you still pick X day to buy $Y of the stock. there is no timing as the only factor you consider is the revolving date you choose to invest on. It doesnt care about price, only that on this date you buy this amount of stock no matter if the stock went up or down.

If what you're talking about is i buy X stock @ Y price today. i'll invest another X dollars if the stock price drops to Z and another X dollars if the price drops to Q. You cant call that DCA. thats another stock buying strategy.

 

[Syringer]

If Google agrees with you, it must be true

 

[imported_Lothar]

Like diversification, DCA doesn't make any sense.
This isn't anything new.

 

[TheoPetro]

Originally posted by: Elbryn

Originally posted by: TheoPetro

Originally posted by: vi edit

Originally posted by: TheoPetro

Originally posted by: Kntx
I don?t think you can say that unequivocally that dollar cost averaging is stupid. If you research a stock and decide that it?s a good investment at $10 a share it follows that if it were to fall to $8 a share it?s an even better investment. So you buy said stock at both $10 and $8 dollars to arrive at a lower average and increase your profit down the line. That being said if it was a bad investment all along no amount of averaging down is going to help you do anything but lose more money.

Bad stocks = DCA is bad
Good stocks = DCA is good

The problem is that you dont know which ones are going to fall more. What if I told you that I liked IBM at anything under $95 (which is pretty much accurate). Say tomorrow IBM goes to $94 should I hold out and invest only a percentage of my $ thinking "hey if it goes down more ill DCA" or should I invest 100% of it because I dont know if it will go down or up from there.

DCA is timing the market, in a round a bout way. I personally dont have the expertise or funds to be able to time the market so for me DCA doesnt make much sense.

Huh?

DCA is the *ANTI* timing. It removes any and all emotion, planning, or research from the equation. It doesn't care about current stock prices, 52w hi/lows PE ratios, ect. It simply says "Buy $X's worth of shares on X day of the month" for most people who use it (401k/s, IRA's investing in indexes, ect).

Im not talking about automatic DCA im talking about an individual investor with X dollars sitting in his trading account making the decision whether or not to DCA when he purchases stock.

I agree that in an automatic (401k) type of deal it does remove the emotion/planning/research. I dont think thats the best way to go about investing (over the company match) but w/e floats your boat.

How is dca with a stock any different than dca with a fund? you still pick X day to buy $Y of the stock. there is no timing as the only factor you consider is the revolving date you choose to invest on. It doesnt care about price, only that on this date you buy this amount of stock no matter if the stock went up or down.

If what you're talking about is i buy X stock @ Y price today. i'll invest another X dollars if the stock price drops to Z and another X dollars if the price drops to Q. You cant call that DCA. thats another stock buying strategy.

With a 401k im assuming you will be making many more small transactions for as long as you are working. What I described, investing X dollars in Y transactions, is a form of DCA. The reason its different is because with a typical 401k you cant just have your investments accrue in an investment account until you decide to purchase something. When youre doing it on your own you can have an account and wait until you have a sufficient amount of dollars you can decide to invest.

Basically DCA with a stock is a shorter term investment strategy than with a 401k. It doesnt have to be an if/then scenario either. Some investors say "I will buy X shares every monday for the next 2 months" and they do it. That to me is DCA.

Any way you slice it, DCA is a cute idea in the same way MM's base theory was a cute idea. When you add in transaction fees and whatnot it falls apart (DCA more so than MM theory).

 

[LegendKiller]

When it comes down to it, DCA is not a terrible idea, nor is it a great idea. It is merely what happens to any normal person who do not have the time to spend timing the market (if anybody can do such a thing).

Does it work? Sure it does, in the long run, just as it would be the same if you had bought at one lower spot, or one higher spot.

Unless you're trading, as opposed to long-term investing, then DCA works.

 

[TheoPetro]

Originally posted by: LegendKiller
When it comes down to it, DCA is not a terrible idea, nor is it a great idea. It is merely what happens to any normal person who do not have the time to spend timing the market (if anybody can do such a thing).

Does it work? Sure it does, in the long run, just as it would be the same if you had bought at one lower spot, or one higher spot.

Unless you're trading, as opposed to long-term investing, then DCA works.

Factor in $7.99/transaction and I think lump sum investing beats the hell out of it. For the average investor whos lump sum is less thank 50k I guess DCA has its place.

 

[dullard]

1) First, most of us don't suddenly have a large lump sum of money to invest. If we did, we should have invested it with DCA months/years BEFORE we wasted the time waiting for it to accumulate into one large pile so that we can invest it in one lump sum. In other words, in a market that goes up is it better to invest $1000/month now or to wait 12 months until we have one large lump of $12,000 to invest? That is, DCA usually means you invest SOONER. When a market is going up, the sooner the better, thus DCA is better in this case.

I hope that I just threw your argument into a 180° loop. The only time that you can do lump sum investing sooner is if you get a sudden windfall - and that just doesn't happen very often. Yes, if you do get a sudden windfall, you MAY be better off investing it all right away.

2) That is, unless the market is flat or if the market is going down, or if the market is in a roller coaster. In all of these three situations, DCA is often better than lump sum (unless you happen to be lucky and time the lump sum at exactly the roller coaster bottom). And we know how poor market timing is.

3) As said in other posts above, DCA helps get people to invest (better emotional control). A little at a time is easier to swallow than a lump sum. If they wait weeks/months deciding where/when to invest the lump sum, then they miss the market gains that the DCA would have given them during that time.

4) DCA gives you flexibilty. It is easier for most people to do DCA and place individual investments in CDs, money markets, their mortgage, bonds, mutual funds, individual stocks, etc. It is harder to figure that all out in one lump at the same time dealing with many different organizations. Or what if you have a sudden need for your money. With DCA, you might not have invested it all yet and face the selling fees/penalties to get your money back out.

But, ultimately you are right. If you happen to have complete emotional control after your windfall in an bull market with proper market timing and a good strategy THEN you are better off in a lump sum. That happens to be a few too many IFs for most people though. Of course, don't be an idiot and do DCA in stocks/bonds a non-retirment investment account as the fees would eat you alive.