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tony

Did Dollar Cost Averaging Work During Depression?

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I am still not sure exactly what he did in his analysis (e.g. did he invest 5%/10%/20%? of his investment on a monthly/quarterly/yearly basis?). Did he just invest in stocks? If he invested in multiple asset classes, did he consider the effect of re-balancing versus no re-balancing?

 

Before someone decides to DCA, they should carefully consider whether it will really provide the result they want.

 

For example, suppose that starting in January Sam starts saving $1,000 each month toward retirement (and this is the maximum amount that he can reasonably save), and he decides to DCA $100 (of the $1,000 total) per month.

 

In January, Sam saves $1,000 and invests $100. Sam has $900 in MM (or some short-term, liquid investment).

 

In February, Sam saves $1,000 and invests $200 ($100 from his January savings and $100 from his February savings). Sam now has $1,700 in MM.

 

In March, Sam saves $1,000 and invests $300 ($100 from his January savings, $100 from his February savings, and $100 from his March savings. Sam now has $2,400 in MM.

 

In April, Sam saves $1,000 and invests $400. Sam now has $3,000 in MM.

 

In May, Sam saves $1,000 and invests $500. Sam now has $3,500 in MM.

 

In June, Sam saves $1,000 and invests $600. Sam now has $3,900 in MM.

 

In July, Sam saves $1,000 and invests $700. Sam now has $4,200 in MM.

 

In August, Sam saves $1,000 and invests $800. Sam now has $4,400 in MM.

 

In September, Sam saves , $1,000 and invests $900. Sam now has $4,500 in MM.

 

In October, Sam saves $1,000 and invests $1,000. Sam now has $4,500 in MM.

 

 

Going forward, the future months would look like October with Sam saving $1,000 per month and investing $100 from that month and $100 from each of the previous 9 months.

 

However, notice that in this scenario, Sam has $4,500 in some sort of short term investment on an on-going basis.

 

There are several important points to notice about this scenario. I will highlight three:

 

1. Sam has probably ended up with a different allocation than he initially intended (with a higher allocation in short term investments). Does this make sense?

 

2. DCA only helped if returns from his overall portfolio allocation fell in the first 9 months and the degree that it helped declined as he moved from January to October.

 

3. After October, DCAing is the equivalent of just maintaining an alternative asset allocation.

 

 

The point of my example (and it is certainly not the definitive example) is that if a person who is making regular contributions (e.g. through a 403B) decides to DCA those contributions, that person should make a plan and be sure that he/she is comfortable with the results of that plan.

 

 

If a person has a lump sum and does not feel that he/she could handle the total draw-down that we have seen in the past for his/her chosen asset allocation, then DCAing is totally beside the point. That person needs to create a more appropriate asset allocation.

 

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