Ben, i’m not sure what point you’re trying to make regarding DCA. Dollar cost averaging is simply buying a target security at periodic times regardless of price to reduce volatility impact on purchasing that security. The source of funds whether it’s from a paycheck or from a lump sum inheritance makes no difference if you are dividing your purchases of a target security overtime then you are dollar cost averaging. Yes, I agree it may indicate some thing about the risk tolerance of the investor but that’s all.
My central point was how most people think of DCA. Investing on payday looks like DCA but it's not if you are investing the money as soon as you can. Some refer to it as "forced DCA" which is much different than true or "optional" DCA where someone has cash they could invest all right now but choose to invest it a little bit at a time.
The issue of "choice" is the major difference.
On that note, if someone chooses to DCA because they are too worried about short term market returns is an incredibly useful indicator about their risk tolerance. It can be much more useful than any risk tolerance questionnaire. At the end of the day you need to be comfortable being fully invested.
To your point on DCA reducing volatility, it's historically not been very effective at reducing volatility.
Ben, I really like your blog and I’m a big fan so I don’t mean to split hairs here but DCA is simply a mathematical thing. If you want to talk about how someone’s choice is affecting their investment decisions and their risk profile then that’s another matter. However, it has nothing to do with DCA. Investor A, using his paycheck decides to buy 1 share of a $100 stock in month one and then systematically in month two he also invests $100 but the stock now costs $200 per share (let’s assume he can buy fractional shares), his DCA weighted cost is $133. Investor B has inherited $100,000 from his grandmother and he decides to dollar cost average into the same stock, in the same amounts and at the same time as investor A . His average cost is also $133. The Masters choices have nothing to do with the results of their DCA.
All that said I do agree with the study that investing a lump sum provides superior returns and that the choices do reflect some thing about an investors risk tolerance. However very hard for me to see how periodic purchases of a given security does not 🟰 DCA regardless of the mental state or net worth of the investor.
By all means, I welcome the splitting of hairs here! Particularly when done thoughtfully (which you are.)
Allow me to further split the hairs.
I would pushback the DCA is not a mathematical thing, it is a strategy. Strategy being a fancy word for an intentional choice.
In your example of Investor A and Investor B, they may have they arrived at the same outcome but by accident.
Let's go back to Investor A who uses his paycheck to invest. Let's say he decided to invest 10% of his salary. He happens to get paid every 2 weeks and invests 10% of that paycheck, so we say that he is dollar cost averaging.
He's still investing all his investable capital as soon as he possibly can which is the definition of lump sum investing.
If he instead he got paid his whole salary on Jan 1st every year, then he has a decision to make. Do I invest the 10% of my annual salary on January 1st or do I break it up and invest in smaller chunks throughout the year?
If he then chooses to invest a predetermined amount of money on a predetermined schedule regardless of current market prices, he's decided to DCA.
If he chooses to invest everything he can on Jan 1st, then he's lump sum investing.
Mechanically, having 10% of your bi-weekly paycheck deposited to a 401k achieves the same result as DCA but it's 100% driven by the fact that we get paid bi-weekly instead of once per year.
Okay, I think I have split all the hairs as far as they will go haha.
Ben, I appreciate appreciate the intellectual debate and have received your subtle hint that enough is enough. I promise this is my last try. If we are playing chess and I choose the Queen‘s gambit as my opening strategy and you flip a coin and the result is that you are “forced” to choose the Queen‘s gambit as your opening then I am pursuing the Queen‘s gambit as a strategy and you are not? Hmm?
Love this article. Thanks Ben! Your thoughts on DCA hit home with me. See the two different scenarios I list below.
1. I used to DCA on a recurring schedule by buying index funds/ETFs over several years via a paycheck deduction into my 401k. DCAing into an index fund like this over a longer time period is less risky because it helps mute the short term market dips and highs, while taking advantage of the long term market trends.
2. When buying individual stocks, I DCA into them in multiple tranches at specific buy points that I identify based on my technical analysis of their stock price charts...this reduces the risk of buying all-in at the high, brings down my average price and maximizes my future gain. Of course the stock can run away after 1-2 tranche purchases and then I have to wait patiently for the next dip which almost always happens.
Ben, I understand your point number 1 but not the message. OK dollar cost averaging with every pay period can be classified and a form of lumpsum investing but isn't the purpose of dollar cost averaging to avoid some of the pitfalls of your point number 4, don't stock pick. Dollar cost averaging is at least a method to invest that avoids trying to time the market and has you investing for the long haul. If you want to make this point about dollar cost averaging what is the alternative? Have a very conservative investment portfolio and just sock money into it as you can spare it? The lesson of dollar cost averaging is that it encourages regular savings and avoids the idea that you can market time. Why highlight this as a misconception? Please give me more insight.
Dollar Cost Averaging in fact is a form of market timing.
You are basically saying I have $10,000 (or whatever amount) I could invest right now, instead of investing the entire amount today, you break it up and invest it a little bit of a time.
Why would anybody do this?
To avoid investing $10,000 today and the market getting cut in half tomorrow. That is market timing and is why investors who dollar cost average consistently underperform investors who invest the entire lump sum as soon as they are able to.
The alternative is to invest all of your "investable" money right away aka "lump sum" investing.
If that means you do it every payday when you have new money available that is what you do.
That's the point that "looks like" dollar cost averaging, but it's not. It's lump-sum investing (investing money as soon as you can) just done every 2 weeks because that's when you have new money.
In summary,
dollar cost averaging= not investing everything you can right now, instead slowly investing it in small amounts over a pre-determined period of time.
Lump sum investing= investing all of your investable money right away.
If you only have new money to invest every payday and you invest that new money on payday, you are lump sum investing.
The last way I'll put it is consider if you got paid next week and had an extra $1,000 from your paycheck to invest.
If you dollar cost averaged that $1,000 you might invest $100 per week over 10 weeks.
If you lump sum invest, you would invest the whole $1,000 right away.
Dollar Cost Averaging is an intentional strategy to ease worried investors. If you are too nervous to invest your money every payday, it might be a sign your portfolio is too risky for you too handle.
Thanks for the prompt response. I guess we are both saying the same thing but in slightly different contexts. I think of dollar cost averaging as a way to invest on a regular basis with a fixed amount you can afford. You are discussing investing a larger lump sum (either saved up or a windfall, like inheritance) over time. In that context I agree that no reason to wait. I would be interested to read the studies you reference that dollar cost averaging underperform lump sum investing if you can cite me to it.
Hey Peter. Indeed it sounds like we are circling the same idea, and our confusion of what each other is saying really proves my first point of how widely misunderstood Dollar Cost Averaging is.
What you are describing is what many call "forced dollar cost averaging" which is investing on payday or shortly after when you have new money. But that is lump-sum investing that looks like dollar cost averaging.
True dollar cost averaging is a more rare event like when there is a windfall of extra cash.
Again thanks. The link is great, not something I have seen before. I know someone who may benefit from reading it, as they are sitting on some cash rather than investing. Makes great points about the realities of investing markets versus the psychology of the investor.
So you blog again opened my eyes to a new perspective. Keep on keeping on with the great work.
Thanks Peter! And if I may be so bold, feel free to share the newsletter with your friend when you send them the Vanguard study ;) Word of moth is how we are growing this blog/newsletter.
Ben, i’m not sure what point you’re trying to make regarding DCA. Dollar cost averaging is simply buying a target security at periodic times regardless of price to reduce volatility impact on purchasing that security. The source of funds whether it’s from a paycheck or from a lump sum inheritance makes no difference if you are dividing your purchases of a target security overtime then you are dollar cost averaging. Yes, I agree it may indicate some thing about the risk tolerance of the investor but that’s all.
Hey Jim,
Good points.
My central point was how most people think of DCA. Investing on payday looks like DCA but it's not if you are investing the money as soon as you can. Some refer to it as "forced DCA" which is much different than true or "optional" DCA where someone has cash they could invest all right now but choose to invest it a little bit at a time.
The issue of "choice" is the major difference.
On that note, if someone chooses to DCA because they are too worried about short term market returns is an incredibly useful indicator about their risk tolerance. It can be much more useful than any risk tolerance questionnaire. At the end of the day you need to be comfortable being fully invested.
To your point on DCA reducing volatility, it's historically not been very effective at reducing volatility.
On a risk-adjusted basis, it consistently underperforms lump-sum investing. Here's a great Vanguard paper detailing this https://static.twentyoverten.com/5980d16bbfb1c93238ad9c24/rJpQmY8o7/Dollar-Cost-Averaging-Just-Means-Taking-Risk-Later-Vanguard.pdf
So in summary, it might seem like I am nitpicking, but it all comes back to getting people to consider if they are in a risk appropriate portfolio.
Hope that makes sense.
Ben
Ben, I really like your blog and I’m a big fan so I don’t mean to split hairs here but DCA is simply a mathematical thing. If you want to talk about how someone’s choice is affecting their investment decisions and their risk profile then that’s another matter. However, it has nothing to do with DCA. Investor A, using his paycheck decides to buy 1 share of a $100 stock in month one and then systematically in month two he also invests $100 but the stock now costs $200 per share (let’s assume he can buy fractional shares), his DCA weighted cost is $133. Investor B has inherited $100,000 from his grandmother and he decides to dollar cost average into the same stock, in the same amounts and at the same time as investor A . His average cost is also $133. The Masters choices have nothing to do with the results of their DCA.
All that said I do agree with the study that investing a lump sum provides superior returns and that the choices do reflect some thing about an investors risk tolerance. However very hard for me to see how periodic purchases of a given security does not 🟰 DCA regardless of the mental state or net worth of the investor.
Hey Jim,
By all means, I welcome the splitting of hairs here! Particularly when done thoughtfully (which you are.)
Allow me to further split the hairs.
I would pushback the DCA is not a mathematical thing, it is a strategy. Strategy being a fancy word for an intentional choice.
In your example of Investor A and Investor B, they may have they arrived at the same outcome but by accident.
Let's go back to Investor A who uses his paycheck to invest. Let's say he decided to invest 10% of his salary. He happens to get paid every 2 weeks and invests 10% of that paycheck, so we say that he is dollar cost averaging.
He's still investing all his investable capital as soon as he possibly can which is the definition of lump sum investing.
If he instead he got paid his whole salary on Jan 1st every year, then he has a decision to make. Do I invest the 10% of my annual salary on January 1st or do I break it up and invest in smaller chunks throughout the year?
If he then chooses to invest a predetermined amount of money on a predetermined schedule regardless of current market prices, he's decided to DCA.
If he chooses to invest everything he can on Jan 1st, then he's lump sum investing.
Mechanically, having 10% of your bi-weekly paycheck deposited to a 401k achieves the same result as DCA but it's 100% driven by the fact that we get paid bi-weekly instead of once per year.
Okay, I think I have split all the hairs as far as they will go haha.
Ben, I appreciate appreciate the intellectual debate and have received your subtle hint that enough is enough. I promise this is my last try. If we are playing chess and I choose the Queen‘s gambit as my opening strategy and you flip a coin and the result is that you are “forced” to choose the Queen‘s gambit as your opening then I am pursuing the Queen‘s gambit as a strategy and you are not? Hmm?
*Investors
Will do both and you have a great one as well.
Love this article. Thanks Ben! Your thoughts on DCA hit home with me. See the two different scenarios I list below.
1. I used to DCA on a recurring schedule by buying index funds/ETFs over several years via a paycheck deduction into my 401k. DCAing into an index fund like this over a longer time period is less risky because it helps mute the short term market dips and highs, while taking advantage of the long term market trends.
2. When buying individual stocks, I DCA into them in multiple tranches at specific buy points that I identify based on my technical analysis of their stock price charts...this reduces the risk of buying all-in at the high, brings down my average price and maximizes my future gain. Of course the stock can run away after 1-2 tranche purchases and then I have to wait patiently for the next dip which almost always happens.
DCA does not work for short term trading.
Ben, I understand your point number 1 but not the message. OK dollar cost averaging with every pay period can be classified and a form of lumpsum investing but isn't the purpose of dollar cost averaging to avoid some of the pitfalls of your point number 4, don't stock pick. Dollar cost averaging is at least a method to invest that avoids trying to time the market and has you investing for the long haul. If you want to make this point about dollar cost averaging what is the alternative? Have a very conservative investment portfolio and just sock money into it as you can spare it? The lesson of dollar cost averaging is that it encourages regular savings and avoids the idea that you can market time. Why highlight this as a misconception? Please give me more insight.
Hi Peter,
Dollar Cost Averaging in fact is a form of market timing.
You are basically saying I have $10,000 (or whatever amount) I could invest right now, instead of investing the entire amount today, you break it up and invest it a little bit of a time.
Why would anybody do this?
To avoid investing $10,000 today and the market getting cut in half tomorrow. That is market timing and is why investors who dollar cost average consistently underperform investors who invest the entire lump sum as soon as they are able to.
The alternative is to invest all of your "investable" money right away aka "lump sum" investing.
If that means you do it every payday when you have new money available that is what you do.
That's the point that "looks like" dollar cost averaging, but it's not. It's lump-sum investing (investing money as soon as you can) just done every 2 weeks because that's when you have new money.
In summary,
dollar cost averaging= not investing everything you can right now, instead slowly investing it in small amounts over a pre-determined period of time.
Lump sum investing= investing all of your investable money right away.
If you only have new money to invest every payday and you invest that new money on payday, you are lump sum investing.
The last way I'll put it is consider if you got paid next week and had an extra $1,000 from your paycheck to invest.
If you dollar cost averaged that $1,000 you might invest $100 per week over 10 weeks.
If you lump sum invest, you would invest the whole $1,000 right away.
Dollar Cost Averaging is an intentional strategy to ease worried investors. If you are too nervous to invest your money every payday, it might be a sign your portfolio is too risky for you too handle.
Hope that makes sense.
Ben,
Thanks for the prompt response. I guess we are both saying the same thing but in slightly different contexts. I think of dollar cost averaging as a way to invest on a regular basis with a fixed amount you can afford. You are discussing investing a larger lump sum (either saved up or a windfall, like inheritance) over time. In that context I agree that no reason to wait. I would be interested to read the studies you reference that dollar cost averaging underperform lump sum investing if you can cite me to it.
Thanks again.
Peter
Hey Peter. Indeed it sounds like we are circling the same idea, and our confusion of what each other is saying really proves my first point of how widely misunderstood Dollar Cost Averaging is.
What you are describing is what many call "forced dollar cost averaging" which is investing on payday or shortly after when you have new money. But that is lump-sum investing that looks like dollar cost averaging.
True dollar cost averaging is a more rare event like when there is a windfall of extra cash.
Here is the Vanguard study which explains the lump sum vs DCA returns over time: https://static.twentyoverten.com/5980d16bbfb1c93238ad9c24/rJpQmY8o7/Dollar-Cost-Averaging-Just-Means-Taking-Risk-Later-Vanguard.pdf
Thanks for the very thoughtful discussion!
Ben,
Again thanks. The link is great, not something I have seen before. I know someone who may benefit from reading it, as they are sitting on some cash rather than investing. Makes great points about the realities of investing markets versus the psychology of the investor.
So you blog again opened my eyes to a new perspective. Keep on keeping on with the great work.
Peter
Thanks Peter! And if I may be so bold, feel free to share the newsletter with your friend when you send them the Vanguard study ;) Word of moth is how we are growing this blog/newsletter.
Have a great weekend.
And re-reading your question, you also mention the link between dollar-cost averaging and picking individual stocks.
These two issues are unrelated.
Dollar-cost averaging is a strategy of how quickly (or slowly) you get your money invested
Picking stocks is a strategy (a poor one) of how to invest that money once you have it invested.
If I were to combine points 1 and 4 together it would be this.
The rational investor who invests in stocks would:
1. Invest all their available cash as soon as possible and get it in the market (lump sum investing)
2. Invest in low-cost index funds that own the whole market rather than invest in individual stocks.
Whether you dollar cost average or lump sum invest, picking stocks is always an irrational choice (almost certain to underperform in the long run)