Dollar Cost Averging: weekly vs monthly

[peter_ross]

There has been lots of studies and research that claim DCA does not work. It only works if the market is volatile or trending down. Studies say one almost always come out ahead investing the entire lump sum at the beginning, in the upward market.

Assuming DCA works, is there any research or analysis that studies the frequency of DCA? Does high frequency DCA work better in a specific market trend?

In other words, if you have $1200 to invest, will you do $100/mo, or $25/week?

[YYZFA]

There has been lots of studies and research that claim DCA does not work. It only works if the market is volatile or trending down. Studies say one almost always come out ahead investing the entire lump sum at the beginning, in the upward market.

Assuming DCA works, is there any research or analysis that studies the frequency of DCA? Does high frequency DCA work better in a specific market trend?

In other words, if you have $1200 to invest, will you do $100/mo, or $25/week?

Which studies say that dollar cost averaging isn't effective?

[budfrogs]

You are probably right. If you have $5K to invest it is probably better to invest all $5K at once. The stock market tends to average a higher rate of return than guaranteed investments.

But if you have $500K to invest and are going to do it in 1 vehicle that $500K may change the stock price because of all the trades in such a short amount of time and it would probably be better to do it over an extended period of time.

Most people use DCA just by default because they are investing a little bit with each pay and do not have a lump sum to put in.

[peter_ross]

Which studies say that dollar cost averaging isn't effective?

There has been quite a few research and webpages:

1. Nobody Gains from Dollar Cost Averaging (http://www2.stetson.edu/fsr/abstracts2/v2-1a4.pdf), by Knight and Mandell, University of Connecticut

2. Dollar-Cost Average Options (http://www.yorku.ca/milevsky/Papers/WP2001C.pdf), by Milevsky and Posner, York University

3. Does Dollar Cost Averaging Work? (http://www.moolanomy.com/129/does-dollar-cost-averaging-work/)

4. Mathematical Illusion: Why Dollar-Cost Averaging Does Not Work (http://habitsforwealth.com/2008/02/10/mathematical-illusion-why-dollar-cost-averaging-does-not-work/), by John G. Greenhut, Ph.D

[YYC27]

I'd buy as often as I have money to buy with (i.e., I'm paid bi-weekly, so I'd buy bi-weekly). If you're buying stocks, or other instruments with commission, you would have to factor that into your decision.

[YYZFA]

There has been quite a few research and webpages:

1. Nobody Gains from Dollar Cost Averaging (http://www2.stetson.edu/fsr/abstracts2/v2-1a4.pdf), by Knight and Mandell, University of Connecticut

2. Dollar-Cost Average Options (http://www.yorku.ca/milevsky/Papers/WP2001C.pdf), by Milevsky and Posner, York University

3. Does Dollar Cost Averaging Work? (http://www.moolanomy.com/129/does-dollar-cost-averaging-work/)

4. Mathematical Illusion: Why Dollar-Cost Averaging Does Not Work (http://habitsforwealth.com/2008/02/10/mathematical-illusion-why-dollar-cost-averaging-does-not-work/), by John G. Greenhut, Ph.D

Thanks for the links. I have skimmed them, and will read them more thoroughly later. I still like dollar cost averaging. It reduces a lot of the risk for me, and it is a really effective method of "forced savings" for me.

It works great in a downturn too. I have nine mutual funds, but I was only doing regular contributions to four of them. After the huge equity crash, I've either recouped all the money I've invested in those four funds, or come very close to it. The other five funds (with initial investments before the markets crashed) are still down significantly.

As to how often I contribute, I do it every two weeks (on the same day I get paid), so I never really see the money to begin with, and I don't miss it.

My investment goals are not to make as much money as possible without considering any risk, so this more balanced plan works best for me.

[GSRee]

In other words, if you have $1200 to invest, will you do $100/mo, or $25/week?

I thought about this awhile ago as I have a large amount being transferred into TD's eFunds. In researching, I came across this: http://en.wikipedia.org/wiki/Dollar_cost_averaging#Confusion

It makes sense that since the market trends upwards, you want to invest lump sum amounts as quickly as possible. If the market is clearly trending down, you might be inclined to DCA instead, or even hold out altogether until bottom, but now you're trying to time the market.

[asdfvcx]

You to need to clarify what you mean by "works".

If you assume that over the long term markets go up, the if you have a lump sum to invest, then investing the whole amount lump will have a higher expected value that DCA. It will also have a higher expected variance. The question then becomes are you willing to accept the higher expected variance for the higher expected return.


Of course, most people don't have a large lump sum to invest and invest every paycheck. So the question really isn't relevant for most people.

[peter_ross]

Thanks for the links. I have skimmed them, and will read them more thoroughly later. I still like dollar cost averaging. It reduces a lot of the risk for me, and it is a really effective method of "forced savings" for me.


Exactly, it says in the articles that DCA is a "psychological" saving technique - not really a win over lump sum.

[YYZFA]

Exactly, it says in the articles that DCA is a "psychological" saving technique - not really a win over lump sum.

It is not just a "psychological" technique for me. It's an effective technique. Each year, I evaluate how much I want to save for that year, and use that figure to determine my biweekly contributions. It's very effective since I never see the money, as it is invested the very same day I get paid, so I don't figure that into my monthly spending budget.

I, like asdfvcx mentioned, do not ever have large sums to directly invest when the market is low, so regular contributions seem to be the best way to go.

I've done my own math, and more often than not, I come out ahead by directly contributing to my mutual funds every two weeks, then I would by depositing my money in a savings account and then buying an investment with the large sum every year. This would be great if I could effectively time the market, and determine when it's at a bottom, but I can't.

[i6s1]

Of course, most people don't have a large lump sum to invest and invest every paycheck. So the question really isn't relevant for most people.

Exactly. Most of don't have a choice between investing all at once or investing as we get paid. It makes no sense for us to save up a lump sum - we'd be missing out on potential market gains.

The key point in the studies is that you shouldn't sit on money that you intend to invest. If you have a lump sum, don't invest it monthly. If you have income monthly, don't save up a lump sum.

[DanielCarrera]

There has been lots of studies and research that claim DCA does not work. It only works if the market is volatile or trending down. Studies say one almost always come out ahead investing the entire lump sum at the beginning, in the upward market.

You can prove anything you want if you tweak the assumptions enough. The truth is that the best time to invest is when you have the money. If you don't have money, it would be a mistake to save money for a few months in order to do a lump sum investment. If you do have money, it would be a mistake to leave it in a bank account earning miserable interest because you want to DCA.

[grant]

There has been lots of studies and research that claim DCA does not work.
There's only 3 things a market can do:

1) go up
2) go down
3) move within a range

Since DCA is better in 2/3rds of the possible scenarios, how can someone claim it "doesn't work" with a straight face?

If anyone knew for sure the market was going to go up: guaranteed, then they're guaranteed to get rich no matter what.

[Wing Nut]

DCA works. It's great for investing from your income.

Lump sums work best probably 80 per cent of the time, if you have lump sums. If not, DCA is great. DCA is also great also for managing risk on a very large sum of money, or when markets are high.

Why would someone argue that DCA doesn't work. It's a great tool. Maybe he's referring to the bolded part above.

[Thalo]

If we knew that the market was "trending upward" ad infinitum, then surely investing everything now would be favorable. If we knew there was no potential possibility for "another shoe to drop", then invest everything now. DCAing isn't meant to get superior returns, it's meant to play the odds. By DCAing I sacrifice the potential returns I could have had by now if I invested all of my money on March 9th, 2009, by reducing the risk that I take a hit on all of my money if the markets crash tomorrow (instead I have money on the sidelines ready to buy after the crash).

In the present situation there is no better strategy than to DCA. If this really is the beginning of a 3-5 year bull market, then there's still plenty of opportunity to buy cheaply in the future (most of our investments we made in 2003, 2004, 2005 are still positive) and if "another shoe drops" then we would want to keep some money on the sidelines to take advantage.

Regarding frequency, the more frequent the better. If you do monthly, do not do month end or month beginning, the markets sometimes have a tendency to rally at month end.

[Thalo]

[B]Lump sums work best probably 80 per cent of the time.

That's the wonderful thing about the stock market, it tends to go up 80 per cent of the time.

[DanielCarrera]

Regarding frequency, the more frequent the better.

No, the frequency should match the frequency of your income. In average stocks return more than money in your bank account, right? So, in average, you'll be better off having money in the market than in your bank account.

[peterpatch]

There has been lots of studies and research that claim DCA does not work. It only works if the market is volatile or trending down. Studies say one almost always come out ahead investing the entire lump sum at the beginning, in the upward market.

Assuming DCA works, is there any research or analysis that studies the frequency of DCA? Does high frequency DCA work better in a specific market trend?

In other words, if you have $1200 to invest, will you do $100/mo, or $25/week?

You don't need a study to show that investing everything at the trough is better then investing partially at the trough and partially higher then the trough.

Once you get it out of your head that you know approximately where the trough is DCA makes sense because it greatly lowers the risk of very short term price fluctuations in the market. However the transaction costs are often higher using DCA then one big lump sum.

[mr_raider]

Assuming I have the funds on hand, should I be making my RRSP contributions monthly, or a single lump sum once a year?

[Thalo]

Assuming I have the funds on hand, should I be making my RRSP contributions monthly, or a single lump sum once a year?

All else being equal, monthly (or whenever your pay cycle is). If it were this year, you would have been better off doing lump sum and given the market valuations back in February, it would have been an easy decision.

Going forward, we don't know for sure if the markets will keep going up, stay level, or take another dive, so given the uncertainty I'd say DCA.

Also, all else being equal, January and February tend to be stronger months for the markets (as many other people plow money into their RRSPs and IRAs and whatnot), so it'd put you at a disadvantage to only be buying equity investments right around that time, once a year.

[Wing Nut]

No, do it in this order:

1. Lump sum annually in advance, if possible.
2. DCA, maybe monthly or whatever works.
3. Lump sum, at year end.

Over time, on average lump sums in advance would be the most profitable strategy.

[seadog83]

Wing Nut, when you say do it as a lump sum annually, you are still DCAing, just on a yearly basis.

DCA is really just another way to diversify yourself. As Warren Buffet says, diversification is really just a way to hedge risk when you don't know what you're doing.

The absolute best case scenario would be to take every cent you had, and do a lump sum when the market is at the very bottom. It is impossible to come out better ahead.

On the opposite end, a lump sum when the market is at the top, and the result could not be worse.

DCAing, you invested half at the top, and half at the bottom. You're better off then the guy who lump summed at the top, but worse off than the guy who lump summed at the bottom. The more frequent/small the purchases (assuming constant amount of $ invested) the more average your returns will be, but risk will also be reduced. Classic risk/reward situation.

[mr_raider]

Wing Nut, when you say do it as a lump sum annually, you are still DCAing, just on a yearly basis.

Well that's the longest interval I can manage due to annual RRSP limits. I can't deposit all the money I need for retirement today!

[Wing Nut]

Wing Nut, when you say do it as a lump sum annually, you are still DCAing, just on a yearly basis.

Yeah, I suppose it is, but I don't think of it as DCAing.