The Motley Fool Discussion Boards
Investing/Strategies / Retirement Investing
|Subject: Re: Roth IRA deposits||Date: 11/17/2003 11:14 AM|
|Author: rkmacdonald||Number: 37871 of 75383|
Author: yobria Date: 11/13/03 4:09 PM Number: 37806
>>It's a lot easier and Dollar-Cost-Averaging (DCA) is a proven practice.
Could you explain why this is? I don't believe in DCA. I invest all my savings whenever I have money. How would I do things differently with DCA?
Studies have shown that it is 'statistically' better to invest a lump sum all at once rather than DCA (Dollar Cost Averaging). This is because the market goes up more than it goes down. It just stands to reason that the sooner you get your money in, the more you will make, most of the time.
HOWEVER, this 'statistical' fact DOES NOT GUARANTEE that you will ALWAYS be better off by investing the lump sum. It only says that MOST of the time you will be better off investing the lump sum all at once.
Consider what can happen if a severe market downturn happens right after you invest a lump sum.
Example: If you had $100,000 to invest and you put it all into VTSMX (Vanguard Total Market Index) on 3/23/00, you would have bought in at at $35.54. Then, less than one month later, on 4/14/00, VTSMX closed at $30.00. That translates to a loss of $15,588 in less than a month. That might even be enough loss to make you pull the plug, which is what many people did at that time (in fact the selling is what makes the price go down).
The reason that most advisors recommend DCA is that it reduces the risk of losing a large amount right after making the initial investment, and most people agree that you cannot predict when a large downturn is coming.
In the example above, if the person had decided to DCA the $100,000 at $10,000 a month, the loss over the first three weeks would have only been $1,588, and the next $10,000 would be invested on 4/23/00 at $31.57 which buys more shares. Then on 5/23/00, another $10,000 at $30.38, which buys even more shares. And so on until the full $100,000 has been invested. DCA, in this case, would have saved this investor a lot of money, and he would have been in an ideal position for the upturn we have seen this year.
But, if this same person had decided to DCA his $100,000 in 1995 at the start of a huge bull run. You can run the numbers and see that he would have been far better off to invest the whole $100,000 at one time, to get all the dollars participating in the bull run for as long as possible.
Note: DCA is quite safe for investing in mutual funds or ETFs, but it can be very dangerous when investing in individual stocks. Remember Enron. Lots of people DCA'd into that stock while it descended to zero, and they lost everything.
So, you can see that DCA is a great way to reduce your risks when investing in the overall market. It will provide significant protection in the event of a downturn. Of course, protection is never free, and DCA will limit your gains in the event of a strong upturn.
There is a variation on DCA called 'Averaging Down' that you might want to consider when you believe the general direction of the market is down. To Average Down, you invest a fixed amount each month ONLY IF THE MARKET HAS GONE DOWN from the previous month. That way, you buy more shares each month as the market descends, but stop investing when it has gone up. Then, when you believe the general direction of the market is up, you invest the rest of the lump sum.
|Copyright 1996-2014 trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us|