Further Reasons Why Dollar Cost Averaging is Best For the Typical Investor

February 21st, 2014 by 

If you have been following us lately, last week we posted an article which argued that typical Americans were better off not trying to time the market when they invested monthly through paycheck deductions (say, 401(k)s or automatic investments in IRAs).  That's right: periodic investing and dollar cost averaging is our opinion of the best option for most investors.

This being the internet, the goalposts were quickly moved and we were forced into the awkward position of attempting to defend the premise of a question that we didn't even ask (it came from here, for the record).  Perhaps our usage of the phrase "market timing" in our original post was a trigger, because the argument of whether or not we answered the original question quickly became a question of whether or not we used the word 'timing' correctly and somehow morphed into whether we were treating market timing fairly as a discipline.

For the record, we don't believe expending tons of effort to pocket $16,000 over 26 years and 308 individual months is worth it.  In fact, due to minimum wage laws, it would be illegal to work for a company which offered that sort of reward.

Since there was one substantive question buried in the mix, we wanted to come back and answer it.  "What about for yearly investing?" - that's a good question since, yes, some investors do invest once a year (say... waiting to fill out their taxes before filling an IRA).  As for the rest of the complaints, please read past the yearly analysis as we've issued a challenge which will help us focus our future efforts to help you with your investing.

If You Invested $6,000 Once a Year and Never Sold, How Much Would Perfect Timing Help?

The answer is still "for most people, not enough to be worth the added stress".  As before, our universe is the dividends reinvested S&P 500 from June of 1988 until February 7, 2014.  Investor A invests steadily - in this case, on the first of June (or whenever the market is open next) annually.  Investor B invests at the high point of the year, and Investor C perfectly calls the market bottom of every year.  I accounted for 2014 by adding $1,000 for their respective dates (A invested on the 7th).  Here is how they finished:

Investor AInvest BInvestor C
(Steady)(Bad Luck)(Brilliant Timer)
Ending Balance$569,081.72$520,015.92$655,185.95
Average Yearly Return*8.66%8.29%9.47%
*Note: I'm using XIRR, which depends on when the investments happen, especially the investment in year one.  That means there is some slop, but I'm not going to go through, predict when A, B, & C added money to the account or put their money in a pseudo-savings account in the meantime to improve comparability on two blog posts.

So - 26 years of efforts, late nights, ulcers, and antacid usage to make... $86,104.23 over 26 years.  $3,311.70 per year.  Worth it?

A Dollar Cost Averaging Challenge to You

Dollar cost averaging spreads risk over time

Market Timing Has Nothing on Time in the Market

First, note that I wasn't trying to make this a challenge between market timing professionals and dollar cost averaging main street investors.  The point of these pieces is to help the everyday investor - people who don't know the definition of, say, margin call.  The people who read our articles on the blog or syndicated through places like Seeking Alpha are an interesting demographic:

  1. We care enough about finance to seek out sources
  2. We're have more education in the markets than most investors
  3. We generally make more money annually than the people who ask us for investing and finance help

With that in mind, if you want me to compare market timing (or any strategy which sells, ever), please give me:

  1. A market timing algorithm (one contrived example: 'Sell when 48% over the 228-day moving average, Buy when 23% below the 44-day')
  2. The sample you used to determine it was a winner - I will be using S&P closes from 1988 until today.  (You must leave me some out of sample room to run the scenario - so try to stop around 1997 or so with your data mining and backtesting.  We're trying to avoid ridiculous - yet entertaining - theoreticals like this.)
  3. Your investing background - years, education, etc.  (Why?  We need to account for #2 above and figure out what it would take to raise main street investors to your level)

I think that with that information we'll be able to fairly decide whether it's worth it for main street investors to employ any sort of timing in their periodic and repeated investing.

Our Household (and the Dollar Cost Averaging Conclusion)

When we redid our master bathroom, my wife (an Interior Designer) asked me to install a shelf in the shower to hold our soaps, shampoos, conditioners and the like.  I did a lot of research into building shelves, liquid waterproofing, supporting the cut studs, moving the electricals, and so on.  I cut the backer board in the freezing rain, and for my efforts, got the dreaded alkaline hands from the holes in my gloves I used grouting (and yes, suffered through soaking them in vinegar after).

All told, I calculated I spent about 50 hours on just the shelf in the shower... between gathering materials, researching, and executing.  What did I get from the experience?  A funny story when people tour my house and a smug sense of superiority every time my wife buys a new bottle of perfectly-fitting Pantene.

In retrospect... was it worth it?  I could have bought a pre-fitted shelf which would have wasted space, sure - but could have cut down my install time by 90-95%.  Pantene may change their bottle size, or my wife may change her hair care ritual (#1 is more likely), and the fit might not be as impressive.  But hey, my shelf is better than the typical shower shelf.  So I've got that going for me... which is nice.

I have no doubt that there are some strategies which would have beat dollar cost averaging.  But remember - even non-market-timer and non-stock-seller Warren Buffett even used $1,000,000 portfolios as his example when he talked about beating the market.  My doubts enter into play when we start talking about whether the typical investor should bother to employ them.

For million dollar plus portfolios?  Sure, no brainer (especially in 1999 dollars). That's why you're reading Don't Quit Your Day Job... and/or reading Seeking Alpha.

For your friend's $90,000 401(k)?

No - set it and forget it.  If he wants to learn on his own, he can adjust his dollar cost averaging strategy in the future.



PK started DQYDJ in 2009 to research and discuss finance and investing and help answer financial questions. He's expanded DQYDJ to build visualizations, calculators, and interactive tools.

PK lives in New Hampshire with his wife, kids, and dog.

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