Dollar cost averaging - Wikipedia

Graham writes that dollar cost averaging "means simply that the practitioner invests in common stocks the same number of dollars each month or each quarter. In ... Dollarcostaveraging FromWikipedia,thefreeencyclopedia Jumptonavigation Jumptosearch Investmentstrategy Dollarcostaveraging(DCA)isaninvestmentstrategythataimstoapplyvalueinvestingprinciplestoregularinvestment.ThetermwasfirstcoinedbyBenjaminGrahaminhisbookTheIntelligentInvestor.Grahamwritesthatdollarcostaveraging"meanssimplythatthepractitionerinvestsincommonstocksthesamenumberofdollarseachmonthoreachquarter.Inthiswayhebuysmoreshareswhenthemarketislowthanwhenitishigh,andheislikelytoendupwithasatisfactoryoverallpriceforallhisholdings." Dollarcostaveragingisalsocalledpound-costaveraging(intheUK),and,irrespectiveofcurrency,unitcostaveraging,incrementaltrading,orthecostaverageeffect.[1]Itshouldnotbeconfusedwiththeconstantdollarplan,whichisaformofrebalancinginvestments. Thetechniqueissocalledbecauseofitspotentialforreducingtheaveragecostofsharesbought.Asthenumberofsharesthatcanbeboughtforafixedamountofmoneyvariesinverselywiththeirprice,DCAeffectivelyleadstomoresharesbeingpurchasedwhentheirpriceislowandfewerwhentheyareexpensive.Asaresult,DCAcanlowerthetotalaveragecostpershareoftheinvestment,givingtheinvestoraloweroverallcostforthesharespurchasedovertime.[2]Thealternatestrategiesaretopurchaseafixednumberofshareseachtimeperiod,ortosaveupthefundsthatareavailableforinvestmentandattempttopurchasesharesattimeswhenthemarketislow,iemarkettiming.AmajoradvantagefortheinvestorusingDCAisnothavingtomakeadecisiononadaytodaybasisaboutthebesttimetoinvestthefunds,butthereareobviousadvantagesinsimplicityandalsoinpromotinghabitualorautomatedregularinvesting. Contents 1Return 2Considerationswhensettingupdollarcostaveraging 3Confusionwithstrategiesforinvestmentofawindfall 4Discussionoftherisksandbenefitsofdollarcostaveraging 5References 6Furtherreading 7Externallinks Return[edit] Giventhatthesameamountofmoneyisinvestedeachtime,thereturnfromdollarcostaveragingonthetotalmoneyinvestedis[3] r = p F p ~ P − 1 , {\displaystyler={\frac{p_{F}}{{\tilde{p}}_{P}}}-1,} where p F {\displaystylep_{F}} isthefinalpriceoftheinvestmentand p ~ P {\displaystyle{\tilde{p}}_{P}} istheharmonicmeanofthepurchaseprice.Ifthetimebetweenpurchasesissmallcomparedtothetotaltimebetweenthefirstpurchaseandthesaleoftheassets,then p ~ P {\displaystyle{\tilde{p}}_{P}} canbeestimatedbytheharmonicmeanofallthepriceswithinthepurchaseperiod.Giventhattheharmonicmeanislowerthanthearithmeticmean,dollarcostaveragingwill,onaverage,resultinalowerpersharepricethanthealternatestrategyofpurchasingafixednumberofshareseachtime.Giventhatthehistoricalmarketvalueofabalancedportfoliohasincreasedovertime,[4]DCAwillalso,onaverage,besuperiortokeepingthefundsoutofthemarketandpurchasingthesharesatalaterdate. Considerationswhensettingupdollarcostaveraging[edit] Indollarcostaveraging,theinvestordecidesonlytwoparameters:thefixedamountofmoneytoinvesteachtimeperiod(i.e.theamountthatisavailabletoinvest)andhowoftenthefundsareinvested.Nofurtherdecisionsneedtobemadeabouteitherthetimingortheleveloffutureinvestmentsandthislendsitselftoanautomaticinvestmentsystemsuchasapayrolldeductionorscheduledbanktransfer.Inmanycasestheinvestmentcanbemadeinlinewiththepaymentofregularincome-forexampleaninvestorwhoispaidfortnightlycansetupafortnightlyautomaticinvestment.However,ifinvestinginassetswithtransactioncosts(forexamplebrokerage)thenfrequentinvestments,particularlyiftheamounttobeinvestedislow,canresultinthedragfromtransactioncostsoutweighingthereturnfromhavingtheinvestmentinthemarketatanearliertime.Thisissuedoesnotariseforthepurchaseofassetswheretransactioncostsareaflatproportionoftheamountinvested,orforinvestmentssuchasmanagedfundswithnotransactioncosts. Forexample,ifthebrokeragecostis$20pertransaction,andtheinvestorhas$500perfortnightavailabletoinvestintoanassetreturning6%perannum,thenthe4%costofthebrokerageishigherthantheexpectedreturnof0.23%ofhavingthe$500investedforthatfortnight.ChangingtheDCAperiodtoevery4weeksdecreasesthecostofthebrokerageto2%oftheinvestedamountandtheexpectedreturnover4weeksis0.46%.Inthissituation,theoptimumperiodwouldbe10weeksasthebrokerageis0.8%andtheexpectedreturnis1.15%. Confusionwithstrategiesforinvestmentofawindfall[edit] Inrecentyears,however,confusionoftheterm"dollarcostaveraging"withwhatVanguardcallasystematicimplementationplanhasarisen.[5]Theterm"dollarcostaveraging"isusedtodescribeadelayedandstagedinvestmentstrategyusedinthesituationwheretheinvestorhasawindfallgainsuchasaninsurancepayoutorinheritance,asopposedtotheimmediateinvestmentoftheentiresum.Thedelayed,stagedstrategyseemspreferablefortheinvestorwhoisconcernedwithavoidingtimingrisk(theriskofmissingoutinbeneficialmovementsinpriceduetoanerrorinmarkettiming)theninsteadofinvestingtheentiresumimmediately,orwaitingforthe(mythical)idealtimetoinvesttheentiresum,theinvestorspreadstheirinvestmentofthewindfallsumintothemarketovertimeinastagedway,whichappearssimilartodollarcostaveraging.Thisbehaviourisdrivenbythefearthatvolatilityinthemarketcouldcauseasignificantdropinthevalueoftheinvestmentimmediatelyaftertheinvestmentismade. Thisconfusionoftermsisperpetuatedbysomearticlesthatrefertothissystematic(delayed)investingofalumpsumasDCA.(AARP,[6]MotleyFool[7])Vanguardspecificallydiscussestheconfusionintheirpaper:"Werefertothegradualinvestmentofalargesumasasystematicimplementationplanorsystematicinvestmentplan.Industrypracticeistorefertosuchstrategiesasdollar-costaveraging;however,thistermisalsocommonlyusedtodescribefixed-dollarinvestmentsmadeovertimefromcurrentincomeasitbecomesavailable.(Afamiliarexampleofthisformofdollar-costaveragingisregularpayrolldeductionsforinvestmentinaworkplaceretirementplan.)Bycontrast,wearedescribingasituationinwhichalumpsumofcashisimmediatelyavailableforinvestment."[8]).However,inotherpublicationsVanguardappeartohavegivenuponclarifyingtheerrorandsimplyrefertothesystematic(delayed)strategyas"dollar-costaveraging"[9][10] Additionalconfusionarisesinsituationswherethereisnowindfallgain,butinsteadaninvestorseekstomakealargechangeintheassetallocationoftheirexistinginvestments.Forexample,theymayhavealargeproportionoftheirinvestmentindefensiveassetssuchascashorbonds,anddecidetochangeasignificantproportiontomorevolatileassetssuchasequities.Againthefearofasuddenfallinthevalueofthemorevolatileassetclassimmediatelyafterthechangeinassetallocationmaymaketheinvestorwishtomakethechangeinasystematic(delayed)fashioneventhoughthisactuallydefeatsthepurposeofthedecisiontomakethechangeinassetallocationinthefirstplace. Discussionoftherisksandbenefitsofdollarcostaveraging[edit] TheprosandconsofDCAhavelongbeenasubjectfordebateamongbothcommercialandacademicspecialistsininvestmentstrategies.[11]Itiseasilydemonstratedmathematicallythatdollarcostaveraging(asdefinedbyBenjaminGraham)issuperiortothealternativesofpurchasingafixednumberofshareswiththesametimeintervals.Iftheexpectationisforanincreasingmarketthenitisalsosuperiortosavingthefundstopurchaseatalaterdate.Whilesomefinancialadvisors,suchasSuzeOrman,[12]advisetheuseofDCA,others,suchasTimothyMiddleton,confusedelayedinvestmentofalumpsumwithDCAandthenclaimitisnothingmorethanamarketinggimmickandnotasoundinvestmentstrategy.[13] AlmostallrecentdiscussionanddebateaboutDCAisactuallybasedonconfusionwiththesituationoftheinvestmentofawindfall,eventhoughthisisactuallyarareeventformostinvestors.Thecontroversyandinterestinthediscussioncomesfromthesuddendiscoveryof"proof"thatthepreviouslyacceptedasoptimalstrategyofDCAhasnowbeendiscoveredtobe"sub-optimal",eventhoughthediscussionisactuallyaboutacompletelydifferentstrategyandsituation.Vanguardspecificallypointouttheyarenotdiscussingdollarcostaveraging,butarticlesdiscussingtheirresultsimmediatelyconfusethestrategybeingdiscussedwithDCA.[14] Vanguard'shistoricalmodelling[15]showedthatinvestingawindfallimmediatelyoutperformedsystematic(delayed)investingtwothirdsofthetime.Thisresultisnotunexpected:ifthemarketisexpectedtotrendupwardovertime,[16]thenasystematicinvestmentplanwhichdelaysinvestmentcanconverselybeexpectedtofaceastatisticalheadwindwhencomparedtoinvestingimmediately:theinvestorischoosingtoinvestatafuturetimeratherthantoday,eventhoughfuturepricesareexpectedtobehigher.Butmostindividualinvestors,especiallyinthecontextofretirementinvesting,neverfaceinvestingasignificantwindfall.ThedisserviceariseswhentheseinvestorstakethesemisunderstoodcriticismsofDCAtomeanthattimingthemarketisbetterthancontinuouslyandautomaticallyinvestingaportionoftheirincomeastheyearnit.Forexample,stoppingone'sretirementinvestmentcontributionsduringadecliningmarketonaccountofthearguedweaknessesofDCAwouldindicateamisunderstandingofthosearguments. Thefinancialcostsandbenefitsofsystematic(delayed)investinghavealsobeenexaminedinmanystudiesusingrealmarketdata.Thesestudiesoftenconfusinglyusethetermdollarcostaveraginginstead,andreveal(asexpected)thatthedelayedstrategydoesnotdeliveronitspromisesandisnotanidealinvestmentstrategy.[17][18][19] Someinvestmentadvisorswhoacknowledgethesub-optimalityofdelayinginvestingawindfallneverthelessadvocateitasabehaviouraltoolthatmakesiteasierforsomeinvestorstostartinvestingawindfalllumpsumormakingachangeinassetallocation.TheycontrasttherelativebenefitsofDCAversusneverinvestingthelumpsumormakingthechange.[20]Onestudyfoundthatthebesttimehorizonwhendelayinginvestingawindfallinthestockmarketintermsofbalancingreturnandriskis6or12months.[21] Recentresearchhashighlightedthebehaviouraleconomicaspectsofsystematic(delayed)investing,whichallowsinvestorstomakeatrade-offbetweentheregretcausedbynotmakingthemostofarisingmarketandthatcausedbyinvestingintoafallingmarket,whichareknowntobeasymmetric.[22]MiddletonclaimsthatDCAhelpsinvestorsenterthemarket,investingmoreovertimethantheymightotherwisebewillingtodoallatonce. References[edit] ^de:Durchschnittskosteneffekt,Retrieved2009-01-12[circularreference] ^CharteredRetirementPlanningCounselorProfessionalDesignationProgram,CollegeforFinancialPlanners,Volume9,page64 ^"Dollarcostaveraginggraph".Retrieved2014-08-28.[citationneeded] ^"LongTermReturns(asurveyofstudies)".Retrieved2011-03-13. ^"Investnowortemporarilyholdyourcash?"(PDF).VanguardResearch.2016.p. 2.Archivedfromtheoriginal(PDF)on12July2021.Retrieved4April2020. ^"Thehiddenbenefitofanautomaticinvestingprogram".Retrieved2009-05-02. ^"Don'tMakeaMillion-DollarMistake".21December2008.Retrieved2009-05-02. ^"Investnowortemporarilyholdyourcash?"(PDF).VanguardResearch.2016.p. 2.Archivedfromtheoriginal(PDF)on12July2021.Retrieved4April2020. ^"Howtoinvestalumpsumofmoney|Vanguard". ^https://static.twentyoverten.com/5980d16bbfb1c93238ad9c24/rJpQmY8o7/Dollar-Cost-Averaging-Just-Means-Taking-Risk-Later-Vanguard.pdf[bareURLPDF] ^ExplainingtheriddleofdollarcostaveragingHayley,SCassBusinessSchoolreport2010 ^"Archivedcopy".Archivedfromtheoriginalon2009-01-01.Retrieved2009-02-13.{{citeweb}}:CS1maint:archivedcopyastitle(link) ^Middleton,Timothy(2005-01-04)."Thecostlymythofdollar-costaveraging".ArchivedfromtheoriginalonSeptember10,2005.Retrieved2009-01-05. ^Kadlac,Dan.IsDollarCostAveragingDumb?Time,Nov.15,2012,accessed11October2016 ^https://static.twentyoverten.com/5980d16bbfb1c93238ad9c24/rJpQmY8o7/Dollar-Cost-Averaging-Just-Means-Taking-Risk-Later-Vanguard.pdf[bareURLPDF] ^"LongTermReturns(asurveyofstudies)".Retrieved2011-03-13. ^Knight,J.R.andMandell,L.NobodyGainsFromDollarCostAveraging:Analytical,NumericalAndEmpiricalResults.FinancialServicesReview,Vol.2,Issue1(1992/93pp.51-61 ^Greenhut,J.G.MathematicalIllusion:WhyDollar-CostAveragingDoesNotWork.JournalofFinancialPlanning,Vol.19,Issue10(October2006),pp.76-83 ^Constantinides,G.M.ANoteontheSuboptimalityofDollar-CostAveragingasanInvestmentPolicy.TheJournalofFinancialandQuantitativeAnalysis,Vol.14,No.2(Jun.,1979),pp.443-450 ^Statman,Meir(18June2015)."DollarCostAveraging:ABehavioralView".Wealthfront.Retrieved25November2020. ^Jones,Bill."DoNotDollar-Cost-AverageforMorethanTwelveMonths".Retrieved2009-01-05. ^[1]UniversityofBuffaloreport Furtherreading[edit] TheIntelligentInvestor:revised1972editionBenjaminGraham,JasonZweig.Collins,2003.ISBN 0-06-055566-1 Externallinks[edit] Investopedia Calculator TunedDCAArticle FinraarticleaboutDCAcaveats SimulateDCAwithfinancialdata vteFinancialmarketsTypesofmarkets Primarymarket Secondarymarket Thirdmarket Fourthmarket Typesofstocks Commonstock Goldenshare Preferredstock Restrictedstock Trackingstock Sharecapital Authorisedcapital Issuedshares Sharesoutstanding Treasurystock Participants Broker-dealer Daytrader Floorbroker Floortrader Investor Marketmaker Proprietarytrader Quantitativeanalyst Financiallaw Regulator Stocktrader Exchanges Electroniccommunicationnetwork Listofstockexchanges Tradinghours Multilateraltradingfacility Over-the-counter Darkpool(privateexchange) 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Returns-basedstyleanalysis Reversestocksplit Sharerepurchase Shortselling Slippage Speculation Stockdilution Stockexchange Stockmarketindex Stocksplit Trade Uptickrule Volatility Votinginterest Yield Retrievedfrom"https://en.wikipedia.org/w/index.php?title=Dollar_cost_averaging&oldid=1093988071" Categories:InvestmentHiddencategories:AllarticleslackingreliablereferencesArticleslackingreliablereferencesfromAugust2015AllarticleswithunsourcedstatementsArticleswithunsourcedstatementsfromMay2022AllarticleswithbareURLsforcitationsArticleswithbareURLsforcitationsfromApril2022ArticleswithPDFformatbareURLsforcitationsCS1maint:archivedcopyastitleArticleswithshortdescriptionShortdescriptionmatchesWikidata Navigationmenu Personaltools NotloggedinTalkContributionsCreateaccountLogin Namespaces ArticleTalk English Views ReadEditViewhistory More Search Navigation MainpageContentsCurrenteventsRandomarticleAboutWikipediaContactusDonate Contribute HelpLearntoeditCommunityportalRecentchangesUploadfile 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