A recent Fidelity artice dropped what was to me twin bombshells: That the value of dollar-cost averaging and of time diversification are both myths or "optical illusions":"Meir Statman, a finance professor at Santa Clara University and author of "What Investors Really Want," had these pearls of wisdom about dollar-cost-averaging and time diversification. "They are both based on the equivalent of optical illusions, but they are useful optical illusions," he said. "After all, movies are optical illusions as well, yet we don't complain. We don't even complain when movies lie, telling us fiction."According to Statman, dollar-cost averaging is commonly recommended as lowering risk. "This is false," Statman said. "But it does lower regret. People who are afraid to invest $100,000 into stocks in a lump sum because the market is sure to drop the day after, can do it at $5,000 each month for 20 months. This also works for people who are afraid to cash $100,000 of stocks in a lump sum, fearing that the market would zoom as soon as they sold."As for time diversification, it's the claim that the risk of stocks is lower when time horizon is longer. "This is false as well, said Statman. "But time diversification can be a way to soothe fears of investors who hesitate to invest in stocks," he said."https://news.fidelity.com/news/article.jhtml?guid=/FidelityF...Note that there is no explanation, just this professor's flat statement that both are false. Is it just one air-headed professor's view, or is is this really the case? Do the contributors here agree? Thanks,Case
As far as DCA, I agree with him. I've had a few "strong discussions" with financial advisers when they touted DCA, pointing out that their examples only work in extreme price variations (+/- 50% from month to month). And further that somebody who used DCA to reduce risk would *not* put money in the market after it lost 50% -- which they must do to achieve the advantage of DCA.Lowering regret is the real benefit of DCA.
I might be wrong, but I think "Dollar Cost Averaging" was coined to describe the idea of putting aside as saving/investment a percentage of your income each month over a very long period of time, as in decades. This is what folks do when they contribute to their company's 401K each paycheck. The idea of what to do with a large lump sum of money that you get via inheritance or something of the like is not the traditional idea of dollar cost averaging. I think the data shows that you should just go ahead and invest a lump sum at one time, then go with the flow.
"People who are afraid to invest $100,000 into stocks in a lump sum because the market is sure to drop the day after, can do it at $5,000 each month for 20 months."This is one version of dollar cost averaging. Another is that you do not have the lump sum of $100,000, but can manage $5,000 at some regular interval.In any case, dollar cost averaging and time diversification should not be viewed as ways to lower risk. Obviously, if you only have so much money to invest over some time period, you should wait until you have enough money to where the fees you pay are small, and then you should invest wisely. Certainly you should stay in cash so long as the market is declining, buy when it is moving up, and sell when it begins to decline. The fact is that nothing beats market timing.Every now and then, somebody writes some piece against market timing. They say something like, "Look at all the people who sold when the market began to decline. Now the market has begun to recover and they are still in cash." Why would they assume that? Whenever I have read such an article, I have been fully invested.
Way back in the day when TMF did some decent educating, there was an article talking about lump sum investing. The example was two people investing the max amount in an IRA once a year. The first always happened to pick the low point of the market to invest each year and the other the high point. Over a decade the difference in CAGR was only a couple points.A couple points can make a difference over a long period of time but it showed that it wasn't double digit. It alleviated the fear of the worse case scenario happening every year.IMHO, DCA is a sleep at night factor when comparing to a lump sum investment.JLC
I agree with Prof Statman on dollar cost averaging a lump sum into the market.Disagree with him that what he calls 'time diversification' is an optical illusion -- at least over the past 140 years for the US stock market. If you've remained invested for at least 30 years, you got a minimum of a 5% annual return. That's not true for shorter periods.http://retireearlyhomepage.com/cagrfun.htmlintercst
"article talking about lump sum investing"Yes. I remember that article. But as I recall (and it was a long time ago), the market had been relatively calm and generally rising during the period in question. It was before the major troubles of 2000 - 2002, and the more recent stuff. If you put up a chart of SPY with distributions re-invested, you can see that from around September 2000 to the present time, SPY has only moved up a little over 13%, or a little over 1%/year compounded. On the other hand, between September 2000 and March 2003, it lost 43%. The decline was worse between Oct. 2007 and March 2009.With movements like that, it does matter when you buy and sell.
...the market had been relatively calm and generally rising during the period in question. The take home wasn't if the market was calm or volatial, it was about showing their wasn't that great of a difference between being perfect on every buy point and being the worst possible investor timing wise. I'm sure 99% of the people would fall in between.It would be interesting to see up to date data, but even with the last two downturns, I doubt the difference is much greater between being perfect and being the worst.JLC
Dollar Cost Averaging vs. Lump Sum investing is a myth, born to soothe the investing psyche of the uneducated (not derogatory) - Think of it this way. You are buying the stock because there is a postive expectation of an increase in value, and over time, the odds are in favor that there will be such an increase. Think about the number of years the average has gone up versus the average going down. And this is true for any set time period - more of those time periods result in up movements than in down movements. So, most of the time Dollar Cost Averaging is just that - A COST!It is a good marketing tool, to ease some into stocks that are nervous, and as well a good tool to increase commissions!Time diversification - in its purest meaning is also a myth. The random walk is just as random over long periods. If the diversification is on ending protfolio value, then the math shows equal risk HOWEVER, as mentioned, if as sometimes is referred, time diversification is just looking at the return of a stock over a time horizon, then a longer time horizon does give a better chance of an increase in value, but also a better chance that if there is a decrease it is a significant decrease. 5% up, 100% down!!d(dollar COST averaging)/dT
As other's have pointed out, the practice of purchasing the same dollar amount at regular intervals helps in several ways1) It helps to force savings. With automatic investing (such as a 401k plan), a set amount is taking each paycheck and invested. If paid in cash, many people would not have the discipline to invest this money. 2) It takes the guesswork out of market timing. Most people can't time the market. Even experiences investors often can't; during the crash of 2008, many people stopped contributing to their 401ks, planning on getting back in when the market turned around, however many missed the bottom. In 2010 it was a big deal that the market was "flat" between 2000 and 2010. A quick calculation shows between 1/31/2000 and 1/19/2010 the S&P 500 dropped around 10%; adjusted for dividends. Someone investing the same amount each week would have been up 5%. If you were able to save your cash and time the two bottoms perfectly, you would have been up 45%, yet if on the other extreme if you bought at each peak you would be down 42%.
2) It takes the guesswork out of market timing.If you have a lump sum, and you have a stock you want to invest in and it is at the price you believe is fair value, then the only thing DCA does for you IS TIME THE MARKET!
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