Monday, August 10, 2009

Statistics to calm nervous investors: Research on dollar cost averaging

Are you--or your clients--nervous about buying stocks? You may find comfort in statistics from "(Re)Entering the Market: The Costs and Benefits of Dollar Cost Averaging" by Gregory D. Singer, director of research, and Ted Mann, analyst in Bernstein Global Wealth Management's New York office. Their article appeared in the CFA Institute's Private Wealth Management e-newsletter (August 2009).


The bottom line, according to the authors' research
...if you have a sum of money to invest for the long term, entering the market all at once will usually prove to be a better strategy than dollar cost averaging. The odds that you will reap greater wealth in the end are in your favor. But dollar cost averaging is reasonable insurance against the risk of investing in a falling market.
The authors highlight the downside of dollar cost averaging. "If the market rises while we are 'averaging in,' we miss out on potential gains. And those forgone gains could be substantial."


As evidence, they present average 12-month rolling returns for the U.S. stock market from 1926 to November 2008 for three strategies of investing a lump sum.
  • Invest All at Once: 12%
  • Dollar Cost Averaging: 8%
  • Hold Cash: 4%
I find these numbers tremendously reassuring, even though past performance is no guarantee of future results. The case for investing all at once is even stronger following 12 months of a down market, with returns of 15%, 10%, and 3% respectively.


However, dollar cost averaging does preserve wealth during the bottom 20% of markets. In this bottom quintile, it "resulted in an average of 11.6 percent more wealth than investing all at once."  So it sounds like a great strategy for declining markets. The hitch? No one can reliably predict when those markets will occur.


Over the long run, investing all at once should outperform dollar cost averaging and holding cash.


The authors concede that investing entire lump sums immediately isn't for everyone. Their research suggests that the potential benefits from dollar cost averaging fall after the first six months. Moreover, "Beyond 18 months, averaging in doesn't make financial sense (unless it's part of a program like payroll deduction, where the money becomes available only over time)."


What do YOU think? When would you recommend investing lump sums all at once vs. dollar cost averaging?

__________________
Susan B. Weiner, CFA
Check out my website at www.InvestmentWriting.com or sign up for my free monthly e-newsletter.
Copyright 2009 by Susan B. Weiner All rights reserved

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.