Friday, January 12, 2007

The Dollar-Cost Averaging Investment Fallacy

The Sun's Financial Diary has a post on dollar-cost averaging (DCA). The post is somewhat drawn out, and the conclusion comes as no surprise. The advantages of DCA are a myth, and if anything, a tool used by mutual funds, insurance companies, etc., to sell you their products.

Why doesn't DCA work? The premise behind DCA is that the risk of loss is reduced by investing over time rather than as a lump sum in case the market takes a nose dive. In the short term your risk of loss would be less, but over time security prices have consistently risen more often than falling.

Here are some additional articles and quotes on the subject:

Timothy Middleton, "The Costly Myth of Dollar-Cost Averaging," "Popular wisdom says scheduling your investments is the best way to make money. But it's actually a sales gimmick to wheedle over time what you won't commit up front."

MoneyChimp, "Does Dollar Cost Averaging Work?" "So why do so many people persist in believing that this old dog really knows how to hunt? Maybe because it has a psychological appeal: if the market dips, people will be happy because DCA will be saving them money; and if the market goes up, people will be happy regardless."

John R. Knight and Lewis Mandell, "Nobody Gains from Dollar Cost Averaging: Analytical, Numerical, and Empirical Results," Financial Services Review, 2(1) 1993, pp. 51-61. "Our results strongly imply that the additional cost and effort associated with Dollar Cost Averaging cannot be justified for any investor, regardless of degree of risk aversion. With the possible exception of its promoters, nobody gains from Dollar Cost Averaging."

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1 comment:

sun said...

Thanks for those excellent articles, though I disagree with your comments that DCA is "a tool used by mutual funds, insurance companies, etc., to sell you their products."

It seems that, as the second quote says, people use DCA is more for psychological reasons as we don't have to worry about the market conditions when making the investment. Over long term, however, any risk of making a lump sum investment will be small and temporary.