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Invest A Lump Sum Or Dollar Cost Average? Just Ask A Rat
FYI: Thanks to her successful side business, Alyssha has saved $130,000. But it’s earning a paltry rate of interest in her savings account. “My husband and I were going to put the annual maximum into our 401K Vanguard accounts. We were going to invest the remainder in a taxable account. But we’re afraid that stocks might drop. What should we do?” Regards, Ted https://assetbuilder.com/knowledge-center/articles/-invest-a-lump-sum-or-dollar-cost-average-just-ask-a-rat
from the Vanguard study, on which this blog note is largely based:
On average, by how much does LSI outperform DCA? To calculate the average magnitude of LSI outperformance, we calculated the average ending values for a 60%/40% portfolio following rolling 10-year investment periods. In the United States, 12-month DCA led to an average ending portfolio value of $2,395,824, while LSI led to an average ending value of $2,450,264, or 2.3% more. [...] It is important to reiterate that these are average returns. Actual experience during any given period in the future may be much higher or lower, depending on market trends.
Measuring the dispersion of outcomes and risk-adjusted performance [...] The 50th-percentile observation is positive (confirming LSI’s average outperform- ance, relative to 12mo DCA), but there is a fairly wide distribution of outcomes. Obviously, it is possible for either strategy to underperform the other over a given period—potentially by a significant amount. [...] Despite its lower average ending portfolio values, a DCA strategy might be more favorable if the risk-adjusted returns of a DCA portfolio during those first 12 months exceed the risk-adjusted returns of an LSI portfolio during that period. However ... this is not the case. LSI has provided better returns and risk-adjusted returns, on average.
This makes me recall my foray into investing in the earlier years of dot com boom. I cost averaged all the way up. Then when market crashed, I was a deer caught in headlights. $250 per month for 20 months I invested. I thought I was so smart.
If I had invested $5000 in one shot, I would have seen my investment more than double, then crash to still above $5000. I would have held that fund. It is too disgusting to discuss how much that would be worth today. Fact of the matter is DCA brought my balance down to way below $5000. I'm simply quoting $5000 as a number here.
I think above episode directly contributed to my hair loss and my cynical attitude toward all experts claiming DCA as the only way for investors. In the long run it might work out yes. As someone has said however, in the long run everyone is dead.
Bottom line, whether one DCAs or not, and whether it worked out or not, will depend on what happens in the future which no one can predict. When you buy will always matter more than What you buy. I would say with this much money, LSI half and DCA the rest.
I'd like to know a little about the investor's risk tolerance; but, since that is not noted ... I'd take the conserative route.
To keep things simple let's say the investor's tolerance for risk called (when fully invested) for a balanced allocation of 10% cash, 40% bonds & 50% stocks. With the current uncertainty of interest rate risk (rising interest rates) and stocks considered to be fully valued (by some) I'd invest up to the low point of my allocation for each asset (bonds & stocks) thus keeping the rest in cash. Thus I might average in to about 25% to bonds, 25% to stocks and keep 50% in cash. From there I'd put the rest to work (over time) based upon market and interest rate movement.
To manage interest rate risk they could ladder the bond allocation spread among a short term bond fund (40%), a intermediate term bond fund (40%) and a little to a long term bond fund (20%). Then within equities diverfication is important so I'd slit equity with about 60% to 75% being in domestic large caps, mid caps and small caps along with putting the residual 25% to 40% to work in foreign positions which would include some exposure to emerging markets.
Just a lot to think on for a first time investor sitting on a pile of cash wanting to enter the market. And, with such little experience, I tip toe in while reading as much as I could about investing. Being a good saver is not the same as being an investor.
Comments
On average, by how much does LSI outperform DCA?
To calculate the average magnitude of LSI outperformance, we calculated the average ending values for a 60%/40% portfolio following rolling 10-year investment periods. In the United States, 12-month DCA led to an average ending portfolio value of $2,395,824, while LSI led to an average ending value of $2,450,264, or 2.3% more. [...] It is important to reiterate that these are average returns. Actual experience during any given period in the future may be much higher or lower, depending on market trends.
Measuring the dispersion of outcomes and risk-adjusted performance
[...] The 50th-percentile observation is positive (confirming LSI’s average outperform- ance, relative to 12mo DCA), but there is a fairly wide distribution of outcomes. Obviously, it is possible for either strategy to underperform the other over a given period—potentially by a significant amount. [...] Despite its lower average ending portfolio values, a DCA strategy might be more favorable if the risk-adjusted returns of a DCA portfolio during those first 12 months exceed the risk-adjusted returns of an LSI portfolio during that period. However ... this is not the case. LSI has provided better returns and risk-adjusted returns, on average.
$250 per month for 20 months I invested. I thought I was so smart.
If I had invested $5000 in one shot, I would have seen my investment more than double, then crash to still above $5000. I would have held that fund. It is too disgusting to discuss how much that would be worth today. Fact of the matter is DCA brought my balance down to way below $5000. I'm simply quoting $5000 as a number here.
I think above episode directly contributed to my hair loss and my cynical attitude toward all experts claiming DCA as the only way for investors. In the long run it might work out yes. As someone has said however, in the long run everyone is dead.
Bottom line, whether one DCAs or not, and whether it worked out or not, will depend on what happens in the future which no one can predict. When you buy will always matter more than What you buy. I would say with this much money, LSI half and DCA the rest.
I'd like to know a little about the investor's risk tolerance; but, since that is not noted ... I'd take the conserative route.
To keep things simple let's say the investor's tolerance for risk called (when fully invested) for a balanced allocation of 10% cash, 40% bonds & 50% stocks. With the current uncertainty of interest rate risk (rising interest rates) and stocks considered to be fully valued (by some) I'd invest up to the low point of my allocation for each asset (bonds & stocks) thus keeping the rest in cash. Thus I might average in to about 25% to bonds, 25% to stocks and keep 50% in cash. From there I'd put the rest to work (over time) based upon market and interest rate movement.
To manage interest rate risk they could ladder the bond allocation spread among a short term bond fund (40%), a intermediate term bond fund (40%) and a little to a long term bond fund (20%). Then within equities diverfication is important so I'd slit equity with about 60% to 75% being in domestic large caps, mid caps and small caps along with putting the residual 25% to 40% to work in foreign positions which would include some exposure to emerging markets.
Just a lot to think on for a first time investor sitting on a pile of cash wanting to enter the market. And, with such little experience, I tip toe in while reading as much as I could about investing. Being a good saver is not the same as being an investor.