If you made it this far, congratulations on finishing this monster post. On concentrated positions, hedging happiness, and the importance of some diversification. However, if you don’t know how you would react to a falling market, or you don’t have the discipline to move your cash to Treasury Bills, than please reconsider following a DCA strategy. Joe works at ABC Corp. and has a 401(k) plan. They had follow-up questions that I never answered like, “What about risk?” or “Did you consider valuations?” and so forth. However, the DotCom Bubble prices didn’t reach June 1997 levels again until July 2002, over 5 years later. If we wanted to visualize how the Buy the Dip strategy works, I have plotted the amount the strategy has invested in the market and its cash balance over this time period: Every time the strategy buys into the market (the red dots), the cash balance goes to zero and the invested amount moves upward accordingly. This one purchase (and its growth) accounts for 52% of the final portfolio value for the Buy the Dip strategy in December 2018. Generally, the longer you wait to deploy your capital, the worst off you will be. In addition, there are two things to notice about this plot: If we put these two points together, this means that Buy the Dip will outperform DCA when big dips happen earlier in the time period. A Lump Sum investment into a 60/40 (stock/bond) portfolio has the same level of risk as Dollar Cost Averaging into the S&P 500 over 24 months, yet the Lump Sum investment is more likely to outperform! A common response I hear when recommending LS over DCA is, “In normal times this makes sense, but not at these extreme valuations!”. Since dips, especially big ones, haven’t happened too often in U.S. market history (i.e. Why is this true? Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data, For disclosure information please visit: https://ritholtzwealth.com/blog-disclosures/. For those of you that skim articles and skipped past the detailed sections above, here’s the punchline: When deciding between investing all your money now (lump sum) or over time (dollar cost averaging), it is almost always better to invest it now, even on a risk-adjusted basis. If we look since 1997, DCA underperforms in 78% of starting months and by 4.8%, on average, by the end of its 24-month buying window: To create this chart we take what the growth of the DCA portfolio would have done over a 24-month period minus the growth of the Lump Sum portfolio over that same time period. The answer to this is a resounding “Yes!” as this chart comparing the standard deviations of these two strategies into U.S. Stocks since 1960 illustrates: As you can see, the standard deviation of LS is much higher than DCA in every period tested (this is also true for other asset classes). However, the typical approach is equal-sized payments over a specific time period (i.e. Members of group savings programs automatically take advantage of market fluctuations and especially short term downturns through dollar cost averaging. Dollar-cost averaging is not a solution for all investment risks, however. 1930s, 1970s, 2000s), this strategy rarely beats DCA. Archives. 04 Jan. Why I’ve Changed My Mind on Bitcoin. Buy the Dip: You save $100 (inflation-adjusted) each month and only buy when the market is in a dip. Statistically, the answer is no. Let’s begin. That is a difference of 226%, which is much larger than any divergences we saw between the DCA and Buy the Dip timing strategies! one payment a month for 12 months). Dollar-cost averaging is a simple but powerful strategy that allows an investor to benefit from turbulence in the stock market without trying to second-guess it. Because if you wouldn’t wait 100 years to get invested, then you shouldn’t wait 100 months or even 100 weeks either. means simply that the practitioner invests in common stocks the same number of dollars each month or each quarter. So though I disagree that the DCA “side cash” should be invested in Treasury Bills due to the evidence suggesting otherwise, I will oblige this request in order to be thorough. In a paper from 2016, Vanguard found that 68% of the time it is better to invest your money right away (“Lump Sum”) rather than buying in over 12 months (“DCA”). For disclosure information please see here. Below I have plotted the S&P 500 (with dividends and adjusted for inflation) over this time period with the all-time highs colored green: Now, I am going to show the exact same plot as above, but I am going to add a red dot for every “dip” in the market (the biggest decline between a pair of all-time highs). The next best time is today. If you liked this post, consider signing up for my newsletter. My biggest takeaways from one of the craziest years in investment history. The only argument I have heard that might make sense for DCA is that it might optimize some investor’s “investing utility” (even if it doesn’t maximize their investment dollars). You must either: If you assume that the assets you are investing in will increase in value over time (otherwise why invest right? Each black bar in the chart below represents how much a $100 purchase grew to by December 2018. Because even an extremely conservative portfolio invested immediately will likely outperform DCA. If you know when you are at a bottom, you can always buy at the cheapest price relative to the all-time highs in that period. Group savings plans and dollar cost averaging. Read More. Outperformance is nice and all, but most investors don’t just care about performance. I hope it makes you re-consider having “cash on the sidelines” ever again. However, you will also notice that there are many less prominent dips that are nested between all time highs. There's a neat little investment trick designed to limit your risk if you want to put a big chunk of money into a single stock. Instead of taking my word for it, let’s dig into the details to see why this is true. Waiting a century to get invested will not be kind to your purchasing power. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data, For disclosure information please visit: https://ritholtzwealth.com/blog-disclosures/. I am not saying that valuations don’t matter, but maybe they matter less than they used to or maybe we don’t have enough data to say at what level they should matter. A “dip” is defined as anytime when the market is not at an all-time high. Missing the bottom by just 2 months leads to underperforming DCA 97% of the time! God still has the last laugh. . La littérature consacrée au Dollar Cost Averaging (DCA) est impressionnante. However, it stops doing as well after the 1930s bear market and does continually worse. This is post 164. To be precise, over 70% of the time, Buy the Dip underperforms DCA (i.e. Dollar cost averaging is an investment strategy that helps investors fight the emotions of a downturn in the markets and potentially profit from systematically buying low when prices fall. Visually, we can see the difference between investing $12,000 through LS vs. DCA over a period of 12 months: With LS you invest the $12,000 (all your funds) in the first month, but with DCA you only invest $1,000 in the first month and hold the remaining $11,000 in cash to be invested in equal-sized payments of $1,000 over the next 11 months. . ] For example, the $100 purchase in January 1995 grew to over $500. And I also know this from the AAII asset allocation survey which shows that, over the last 20 years, the average individual allocation to cash is 22%! I know what some of you are thinking. So, which strategy would you choose: DCA or Buy the Dip? The only other rule in this game is that you cannot move in and out of stocks. This is opposed to waiting until you have accumulated a large, lump sum, and then investing it all at once. We can extend this analysis back to 1960 (using the Shiller data) and we would see similar results: The only times when DCA beats LS is when the market crashes (i.e. Now that we are on the same page regarding definitions, I am going to give you the punchline now:  Dollar cost averaging will underperform lump sum investing for most asset classes most of the time. When the black line is below 0%, these are periods where DCA underperforms LS, and when it is above 0%, these are periods where DCA outperforms LS. OfDollarsAndData.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com and affiliated sites. If you want to average in over a shorter buying window (i.e. There is just one problem with this theory—most investors don’t follow it. Starting in 1975, the next all-time high in the market doesn’t occur until 1985, meaning there is no dip to buy until after 1985. So, if you are a disciplined investor who can DCA into a falling market while keeping your sideline cash invested in Treasury Bills (or an equivalent T-Bill index), than you might just be better off than doing a Lump Sum investment. However, as I have addressed in a previous post, LS can still outperform DCA while using a similar or lower risk portfolio. https://github.com/nmaggiulli/of-dollars-and-data, https://ritholtzwealth.com/blog-disclosures/. Dollar cost averaging is an investment strategy designed to reduce volatility in a portfolio by purchasing an investment in fixed increments, rather than all at once. This is true because you are investing all of your available money immediately. Elle est aisée à comprendre et à la portée de tout investisseur. Proponents of DCA argue that as it reduces the average cost of investing (since more securities are purchased in periods when the price is relatively low), it must generate higher returns. I ran a variation of Buy the Dip where the strategy misses the bottom by 2 months, and guess what? Going back to the thought experiment from the previous section, when assets rise LS outperforms DCA, but when assets fall, DCA outperforms LS. Nick Maggiulli is the Chief Operating Officer for Ritholtz Wealth Management LLC. Lump Sum Investing This week’s Money Guy Episode is inspired by an article written by Nick Maggiulli Of Dollars and Data on February 19, 2019 titled “ How to Invest a Lump Sum ” that talks about what you should do if you suddenly experience a windfall of money. We can take this same logic and generalize it downward to periods much smaller than 100 years. This is the last article you will ever need to read on market timing. However, after my prior post on lump sum investing, lots of individuals cried out that this side cash should be invested in Treasury Bills while the DCA strategy gets invested. However, if we break the performance out by CAPE Percentile we see that DCA always underperforms LS even on a risk-adjusted basis: The size of DCA’s underperformance does shrink as valuations get more extreme, but, unfortunately, as we try to analyze the periods with the highest valuations, we run into sample size problems. Despite writing on this topic previously, a sizable minority of my readers didn’t seem satisfied with my work. There is no other time period in U.S. market history that even comes close to this. Consider placing this money in a more conservative portfolio now and move on with life. The best example of this is the period 1928-1957, which contains the largest dip in U.S. stock market history (June 1932): Buy the Dip works incredibly well over this period because it buys the biggest dip ever (June 1932) early on. I wrote this post because sometimes I hear about friends who save up cash to “buy the dip” when they would be far better off if they just kept buying. The size of the DCA’s underperformance will vary over time, by asset class and by how long you take to average into your market of choice. CAPE >25). Dollar-cost averaging (DCA) is a common investment strategy where a fixed amount of capital is periodically invested into a certain asset to reduce the effects of volatility in the market. When you buy periodically into the market (i.e. Even God Couldn’t Beat Dollar Cost Averaging: The Problem with Buying the Dip; Dollar Cost Averaging vs. However, the only time when CAPE was >30 before modern times was the DotCom Bubble! For example, if you were to LS into a 60/40 (U.S. stock/bond) portfolio you would outperform DCA into a 100% stock portfolio in most periods: More importantly though, you would take roughly the same level of risk while doing so: Think about what this means. For example, the best 40-year period between 1920 and 1979 was from 1922-1961, where your $48,000 (40 years * 12 months * $100) in total purchases grew to over $500,000. This is why dollar-cost averaging in this context makes absolutely no sense. Summary: Dollar Cost Averaging is one of the most widely held beliefs on investing methodologies. For example, if you had started buying into the market in January 2005 over the next 24 months, the DCA strategy would have underperformed a similar Lump Sum investment in January 2005 by about 10%. Dollar cost averaging. Of Dollars And Data focuses on personal finance using data analysis. While I have used this definition of dollar cost averaging previously (see this post), this is not the dollar cost averaging I am referring to in this post. If an asset class is going to rise over the long run (and most asset classes have historically) you should buy before that rise occurs (LS) instead of while that rise is occurring (DCA). February 2003, March 2009) where some payments grow to a lot more than others. Your strategy is less important than what the market does. Posted February 25, 2020 by Nick Maggiulli. More importantly though, the average Sharpe ratio of DCA is now generally higher than the Sharpe ratio for LS for nearly all but one of the asset classes tested (hint: Bitcoin). Even God couldn’t beat dollar-cost averaging. What makes the Buy the Dip strategy even more problematic is that we have always assumed that you would know when you were at every bottom (you won’t). 1 January 2020 (updated annually) Dollar cost averaging is simply the term used to describe the strategy of making regular incremental investments over a period of time as opposed to a one-off lump sum investment. To start, let’s play a game: Imagine you are dropped somewhere in history between 1920 and 1979 and you have to invest in the U.S. stock market for the next 40 years. For example, if we only consider when CAPE > 30 (about the level it was at the end of 2019), DCA outperformed LS by 2.7% on average over the next 24 months. “Dollar-cost averaging [ . There are a handful of big dips (i.e. It’s like the saying goes: The best time to start was yesterday. Why? 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