My Worst Investment Ever Podcast Enrich Your Future 26: Should You Invest Now or Spread It Out?
In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 26: Dollar Cost Averaging.
LEARNING: Invest all your money whenever you have it.
“If you want to put the odds in your favor, which is the best we can do because we don’t have clear crystal balls, you should put all your money in whenever you have it to invest.”
Larry Swedroe
In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.
Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 26: Dollar Cost Averaging.
Chapter 26: Dollar Cost Averaging
In this chapter, Larry discusses why lump sum investing is better than dollar cost averaging.
Should you invest your money all at once or spread it over time?
According to Larry, the issue of Dollar Cost Averaging (DCA) typically arises when an investor receives a large lump sum of money and wonders if they should invest it all at once or spread it over time. The same problem arises when an investor panics and sells when confronted with a bear market, but then there are two questions: How does the investor decide when it is safe to reenter the market? And does she reinvest all at once or by DCA?
Constantinides, a University of Chicago professor in the 1960s, studied this question. He demonstrated that DCA is an inferior strategy to lump sum investing. He termed it logically dumb as it makes no sense based on an expected return outcome. From a purely financial perspective, the logical answer is that if you have money to invest, you should always invest it whenever it’s available.
Another paper by John Knight and Lewis Mandell compared DCA to a buy-and-hold strategy. Then, it analyzed the strategies across a series of investor profiles from risk-averse to aggressive. They concluded that DCA had no advantage over the two alternative investment strategies. Combined with their graphical analysis, their numerical trial and empirical evidence favored optimal rebalancing and buy-and-hold strategy over dollar cost averaging. Optimal rebalancing refers to the strategy of adjusting the proportions of assets in a portfolio to maintain a desired level of risk and return.
Dollar cost averaging versus lump sum investing
Knight and Mandell conducted a backtest to compare the performance of DCA versus LSI (lump sum investing). Backtesting is a simulation technique to evaluate the performance of a trading strategy using historical data. They backtested the two strategies between 1926 and 2010. Transaction costs were ignored (favoring DCA, which involves more trading). The authors assumed the initial portfolio was $1 million in cash, and the only investment available was the S&P 500 Index:
- DCA Strategy: At the beginning of each month, one-twelfth of the initial portfolio was invested—the entire $1 million was invested by the end of the 12th month.
- LSI Strategy: The $1 million portfolio was invested on day one.
The study covered 781 rolling 20-year periods. The LSI strategy outperformed in 552 of them—over 70 percent of the time. In addition, in the roughly 30 percent of instances in which DCA outperformed, the magnitude of that outperformance was less than when LSI outperformed.
Specifically, during the 552 20-year periods in which LSI did better than DCA, the average cumulative outperformance was $940,301 on the initial $1 million investment. During the 229 periods in which DCA did better than LSI, the average cumulative outperformance was $769,311.
When dollar cost averaging is the better option
Larry notes that there is an argument to be made in favor of DCA when it is the lesser of two evils—when an investor cannot “take the plunge” because they are sure that if they were to invest all at one time, that day would turn out to be the high not exceeded until the next millennium. That fear causes paralysis.
If the market rises after they delay, how can they buy now at even higher prices? And if the market falls, how can they buy now because the bear market they feared has arrived? Once a decision has been made not to buy, how do you decide to buy?
There is a solution to this dilemma that addresses both the logical and the emotional issues. Larry advises an investor to write a business plan for their lump sum. The plan should lay out a schedule with regularly planned investments. The plan might look like one of these alternatives:
- Invest one-third of the investment immediately and invest the remainder one-third at a time during the next two months or the next two quarters.
- Invest one-quarter today and spread the remainder equally over the next three quarters.
- Invest one-sixth each month for six months or every other month.
Adopt a glass is half-full perspective
Having accomplished these objectives, Larry says, the investor should adopt a “glass is half full” perspective. If the market rises after the initial investment, they can feel good about how their portfolio has performed. She can also feel good about how smart she was not to delay investing.
If, on the other hand, the market has fallen, the investor can feel good about the opportunity they now have to buy at lower prices and about being smart enough not to have put all of their money in at one time. Either way, the investor wins from a psychological perspective. This is an important consideration because emotions play an essential role in how individuals view outcomes.
Lump sum investing is the way to go
While DCA may sometimes work, Larry insists that putting all your money at once gives you the best odds of having the most money. If you want to put the odds in your favor, which is the best we can do because we don’t have clear crystal balls, he says, you should put all your money in whenever you have it to invest. Unfortunately, despite all the evidence, investors and advisors still recommend DCA.
Further reading
- George Constantinides, “A Note On The SubOptimality Of Dollar Cost Averaging as an Investment Policy,” The Journal of Financial and Quantitative Analysis, June 1979.
- John Ross Knight and Lewis Mandell, “Nobody Gains From Dollar Cost Averaging: Analytical, Numerical and Empirical Results,” Financial Services Review, Volume 2, Issue 1 (1992-1993) pp. 1-71.
- Gerstein Fisher, “Does Dollar Cost Averaging Make Sense For Investors?” 2011.
Did you miss out on the previous chapters? Check them out:
Part I: How Markets Work: How Security Prices are Determined and Why It’s So Difficult to Outperform
- Enrich Your Future 01: The Determinants of the Risk and Return of Stocks and Bonds
- Enrich Your Future 02: How Markets Set Prices
- Enrich Your Future 03: Persistence of Performance: Athletes Versus Investment Managers
- Enrich Your Future 04: Why Is Persistent Outperformance So Hard to Find?
- Enrich Your Future 05: Great Companies Do Not Make High-Return Investments
- Enrich Your Future 06: Market Efficiency and the Case of Pete Rose
- Enrich Your Future 07: The Value of Security Analysis
- Enrich Your Future 08: High Economic Growth Doesn’t Always Mean High Stock Market Return
- Enrich Your Future 09: The Fed Model and the Money Illusion
Part II: Strategic Portfolio Decisions
- Enrich Your Future 10: You Won’t Beat the Market Even the Best Funds Don’t
- Enrich Your Future 11: Long-Term Outperformance Is Not Always Evidence of Skill
- Enrich Your Future 12: When Confronted With a Loser’s Game Do Not Play
- Enrich Your Future 13: Past Performance Is Not a Predictor of Future Performance
- Enrich Your Future 14: Stocks Are Risky No Matter How Long the Horizon
- Enrich Your Future 15: Individual Stocks Are Riskier Than You Believe
- Enrich Your Future 16: The Estimated Return Is Not Inevitable
- Enrich Your Future 17: Take a Portfolio Approach to Your Investments
- Enrich Your Future 18: Build a Portfolio That Can Withstand the Black Swans
- Enrich Your Future 19: The Gold Illusion: Why Investing in Gold May Not Be Safe
- Enrich Your Future 20: Passive Investing Is the Key to Prudent Wealth Management
Part III: Behavioral Finance: We Have Met the Enemy and He Is Us
- Enrich Your Future 21: Think You Can Beat the Market? Think Again
- Enrich Your Future 22: Some Risks Are Not Worth Taking
- Enrich Your Future 23: Seeing Through the Frame: Making Better Investment Decisions
- Enrich Your Future 24: Why Smart People Do Dumb Things
- Enrich Your Future 25: Stock Crashes Happen—Be Prepared
About Larry Swedroe
Larry Swedroe was head of financial and economic research at Buckingham Wealth Partners. Since joining the firm in 1996, Larry has spent his time, talent, and energy educating investors on the benefits of evidence-based investing with an enthusiasm few can match.
Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has authored or co-authored 18 books.
Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television on various outlets.
Larry is a prolific writer, regularly contributing to multiple outlets, including AlphaArchitect, Advisor Perspectives, and Wealth Management.
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