Dollar Cost averaging

[ea1776]

If there are huge institutional sell-offs happening, chances are the mutual fund managers are among the sellers. If I'm dollar-cost-averaging into a mutual fund, that is not the same as if I was dollar-cost-averaging into an individual stock. The money going into my funds today is not buying the same basket of stocks that it was buying 6 months or 1 year or 5 years ago.

True, but you are still buying stocks is my point. Not all huge institutional investors are fully invested in the stock market at all times.

[disneysteve]

DCA gets a bad rap because of the recession

This is really ironic. When stocks were only going up, folks were all in favor of DCA. When prices started dropping, people started questioning the value of DCA. That makes no sense at all. When prices are only going up, DCA is actually a lousy strategy. I had that thought often. One month, I sent in money and bought shares at $85. The next month, it was $86.50. The month after that it was $87.95. I would have been better off dumping the money in all at once.

The benefit of DCA comes when the price drops and you get to snatch up more shares for your money. The lower the price goes, the more shares your money buys. Eventually, when the market turns around and prices start climbing again, you are in much better shape to benefit from the recovery. It works just fine. I've seen it in my own portfolio this past year.

You have to remember that DCA is a long-term strategy. You can't look at short-term results (in highly unusual market conditions) and throw out a perfectly good long-term plan as a result.

[ea1776]

Funny, that's similar to what I ran into elsewhere....

For one thing, not all expense ratios are created equal. Some charge a lot. Some don't. Vanguard's retirement funds are typically 0.19%. That's $190 a year for every $100,000 invested with them. And that's before Admiral Share! Come on, $190 to take care of $100k of your retirement money? It's not really all that bad is it?

FWIW, my point was not that funds are expensive, but rather that the people running the funds want you to DCA b/c that's how they get paid. Obviously, they'd want you to buy managed funds over indexed, but investors buying anything is better than investors raising cash to them.

[disneysteve]

True, but you are still buying stocks is my point. Not all huge institutional investors are fully invested in the stock market at all times.

I disagree. My overall portfolio is not all stocks. As BA pointed out, DCA is not just about stocks or stock mutual funds. We DCA into bonds. We DCA into a REIT. We DCA into a gold and precious metals fund. You could even say we DCA into cash accounts since interest rates fluctuate. A CD purchased 6 months ago is earning a different amount than one bought today.

Also, even within a stock mutual fund, the fund has a certain percentage of assets in cash and that percentage fluctuates based on market conditions. If the manager feels the market is overvalued, he may cut back the stock holdings and boost the cash reserves, so the money I'm sending in each month may actually be increasing my own cash exposure as a result.

[disneysteve]

the people running the funds want you to DCA b/c that's how they get paid.

And stock brokers would like you to invest on your own because that's how they get paid. No matter how you do it, somebody makes money off of your business.

When you think about it, the mutual fund managers have more incentive to help you make money because they get a percentage of assets under management. If your account grows in value, they get more money. A stock broker only gets a commission when you buy and when you sell. It doesn't matter to them if the stock goes up or down and they don't want you to buy and hold. They want you to trade more frequently. I'd rather deal with the fund manager who has an incentive for me to do well.

[Merch]

The way the buyside makes money (mutual funds) is assets under management. The more assets, the more money they make.

I agree that DCA is the best way of investing. It takes the emotion out of investing which will hurt you more then anything. But what people are really missing is rebalancing their portfolios. This is where you get more bang for your buck.

Let's say you set up a simple allocation of 80% stock and 20% bonds in 2 index funds. When stocks rally, you may end up with 87% stock and 13% bonds. The idea is once or twice a year to rebalance your portfolio. So you would sell stocks and buy bonds to get back to 80/20.

The idea is 2 fold: 1) the protfolio above moved into a more risky portfolio then you originally set up 2) you are selling appreciated assets for assests that are under appreciated. Morningstar recommends every 18 months.

Our Rebalancing Principles

Fidelity has an interesting chart showing one year's dog being the next year's star.

Retirement Plan- Guidelines for Rebalancing your Portfolio

[disneysteve]

But what people are really missing is rebalancing their portfolios.

Exactly. I meant to mention rebalancing earlier.

DCA does NOT mean that you just put money in endlessly and never sell and never rebalance. A couple of times, I've actually partially rebalanced by donating greatly appreciated shares to charity. It locked in the profit on those shares and I avoided paying taxes on that gain along with getting a tax deduction for the donation. And in the process, lessened my stock exposure at a time when things were very overvalued.

[ea1776]

And stock brokers would like you to invest on your own because that's how they get paid. No matter how you do it, somebody makes money off of your business.

Who makes money on me raising cash? They may make a little on money market assets, but nothing compared to buying stuff.

When you think about it, the mutual fund managers have more incentive to help you make money because they get a percentage of assets under management. If your account grows in value, they get more money. A stock broker only gets a commission when you buy and when you sell. It doesn't matter to them if the stock goes up or down and they don't want you to buy and hold. They want you to trade more frequently. I'd rather deal with the fund manager who has an incentive for me to do well.

That's true. But I'm not arguing that we should "trust brokers and not mutual fund managers". My only argument is that the well-informed, motivated, individual investor can achieve a better long term performance than DCA'ing into some target retirement fund or other "set it and forget it" approach.

[Broken Arrow]

I agree that DCA is the best way of investing. It takes the emotion out of investing which will hurt you more then anything. But what people are really missing is rebalancing their portfolios. This is where you get more bang for your buck.

Yes, silly me, I didn't mention the biggest advantage of DCA, which I've emphasized in bold. For literally next to no effort on your part, it helps you invest while helping you mitigate the biggest risk of all: Investor risk. We are often times our own worst enemy.

Plus, I have only implied but not specifically mentioned asset allocation, and for that matter, rebalancing, which is actually much more important than how you DCA.

[Broken Arrow]

By the way, most of the criticism against DCA typically points back to a white paper (more like an op-ed) written by Dr. Greenhut of Texas A&M. Here's a link to his article by the way. It's long and some of the images are missing, but it's informative and good critical thinking just the same.

However, it's also worth noting that he's not entirely AGAINST the idea of DCA. In fact, he agrees with some of the advantages of DCA, which is most applicable with average individual investors such as you and I.

What he IS debating is specifically HOW DCA is being applied. Here's a quote from his own article:

Two researchers (Williams and Bacon) have discounted dollar cost averaging by statistically showing that putting all the funds in at one time outproduces dollar cost averaging by two to one. They invested a theoretical sum in 90 day T-bills and moved into the S&P 500 over a year's period. They compared these results with investing all the funds at once- starting with different periods from 1926 to 1991.

Now, I do have a few concerns about this. First of all, it's back-testing, and therefore should be taken with a grain of salt. Second of all, they're STILL DCA-ing! They're just doing it annually rather than bi-weekly or monthly.

Even if we are to ignore these two misgivings, this is still no proof that DCA is ineffective, merely that by back-testing the numbers, annual DCA produced a higher return than monthly DCA. And why is that? I don't know. Does anyone know? I don't. I think it's more like a fluke. I think they are seeing a pattern in the random market noise that doesn't exist. Besides, if it WAS true, then what month should we invest every year then, if there is one? October? Should I go get some darts and a dartboard?

It should also be added that Dr. Greenhut is referencing to two researchers, and he himself did not back-test these numbers. In fact, the examples he gave are made-up, and not based on actual historical performances.

But maybe they still have a point. Or maybe not. Either case, the one overriding factor that I think everyone agrees on is that, in order to out-perform DCA returns, one has to be highly knowledgeable and highly engaged in the field of investing. You have to constantly monitor the market and valuate your equities.

I never disagreed with that, but back in real life, not everyone is actually interested in the exercise of active investing, and fewer still have the knowledge and skill to pull it off successfully.

So, this is why criticizing DCA perplexes me so much. A perfect analogy for this is arguing that manual transmissions are better than automatic transmissions. Maybe, maybe not. It depends on so many things, doesn't it? It depends on the transmission design, the quality of the build, and perhaps most important of all, who is driving it. In the hands of an expert race car driver, maybe manual is better. However, for the rest of the world, many are perfectly happy with automatic transmission.

Also, doesn't it suggest that the driver's skill is more important than the type of transmission used, just as the investor's skill is more important than when they contribute to their funds?

Actually, I do buy-and-sell, and time the market as well. I just don't expect to be as good at it as Buffett, just as I do not expect to drive as good as Jeff Gordon.

[tmvijai]

A perfect analogy for this is arguing that manual transmissions are better than automatic transmissions. Maybe, maybe not. It depends on so many things, doesn't it? It depends on the transmission design, the quality of the build, and perhaps most important of all, who is driving it. In the hands of an expert race car driver, maybe manual is better. However, for the rest of the world, many are perfectly happy with automatic transmission.

Also, doesn't it suggest that the driver's skill is more important than the type of transmission used, just as the investor's skill is more important than when they contribute to their funds?

What a perfect analogy?! Good explanation as well BA. It does clear the mud. I read an good article on the same topic in the qtrly magazine from troweprice at page 8 titled Systematic investing. T. Rowe Price Investor - June 2009

It also might answer questions steve raised on why DCA is good BEAR TO BULL and not in BULL TO BEAR market with some examples. It is a good read.

DCA is also a matter convinence as many agreed. We are busy with our own world and can't read every technical analysis books to be expert on timing and find the market correction to enter and exit. You can only play around with some quick money but not the whole retirement amount. So we all depend on the experts who does it for bread and butter to take us thru the hurdles and reach the destination. Thats what it matters. You can travel yourselve and be adventurous. You might reach ahead or lot of chances to miss the path and get lost. It is possible. It is wise to follow a guide who can take you along.

In the discussion, it mainly assumed DCA thru mutual funds but many also explained you can do DCA in anything available to invest. Its all your preference. I been using sharebuilder to do DCA in stocks and its is working out well. But I do bit of market timing added to make it work better to what I wanted. It working out so far in the bear market but have to wait and watch on bull.