Dollar Cost Averaging…

Dollar Cost Averaging is as highly debated as any topic in finance. Most of the negative arguments tend to fall into the “it’s better to just invest the lump sum” variety, which ignores one of the very important factors that several personal finance “professionals” seem to ignore.

What if I don’t have the lump sum at the beginning? Seriously, simple simon. If I had the lump sum up front, sure, it probably makes no sense to hold onto part of it (unless it’s making some seriously good interest). But redo your table there to indicate a real world situation where you’re trying to save up the $3000 lump sum for 10 months, and extend it some. Let’s see what that gets us (I’m making the same assumptions of purchase time as the article for the DCA investor, and ignoring the dividends reinvestment, for simplicity’s sake)

Mr. DCA ends up with 113.31 shares, and a December 27th value of $3235, give or take some decimal points I left off. Mr. Lump Sum buys all $3000 of his stock when he has the cash saved, on 10/01 and ends up with 112.57 shares with a Dec 27th value of $3213.87. Twenty two bucks isn’t gonna be the difference between life and death, but it certainly is more. I’m willing to bet if you repeated this year after year until now, assuming it takes 10 months to wad up enough cash to lump sum it, you’ll end up with more stock as Mr. DCA, likely (but not definitely) purchased at a better price. Outside of a stock market dump, where Mr. Lump Sum is protected by having his bundle in cash and can invest at a much lower rate, the DCA plan is better for those who don’t have the cash up front. Of course, his “random” assumptions aren’t great either, as it’s not really random, it’s just ten small investments, which is… Dollar Cost Averaging.

The reason I’m thinking about this is because while the stock market is puking up it’s guts right now and everybody is freaking out, I’m trying to remain fairly calm and just accept this as something of a gift. I don’t have a lump sum to invest (and right now would be a pretty OK time to do it in my entirely amateur opinion), so I have to just let my 401k soak up a couple more shares per dollar until this sorts itself out.

Anyone have any good reasons why my DCA example doesn’t work? Let me know.

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