• Home
  • About
  • Services
  • Contact
  • Media

To DCA or not to DCA: that is the question (Part 2)

Posted October 31, 2013 by Denis Smirnov

In the last post I explored the math behind DCA.  I’m going to expand on that analysis and later address some of the real-world issues associated with investing lump sums of cash.

Exhibit 1 below adds bonds to the “DCA Advantage” analysis as well as 60/40 portfolio (60% stocks, 40% bonds).  The bonds in this case are represented by the Vanguard Total Bond Market Index (VBMFX) – it’s a very broad index of investment-grade U.S. bonds and unlike many other bond index funds it has been around since 1986.

After including bonds, the DCA Advantage rules hold – DCA is good in the down market and bad in an up market.  The results are what one would expect – adding bonds to the portfolio smoothes out the returns and reduces volatility.  This holds true for the DCA Advantage part of the analysis as well.  What’s most interesting to me is the revelation that DCA “eats away” about 20-25% of the cumulative return over the period in both stocks/bonds and the combined portfolio.  That’s a pretty steep price for feeling a little more comfortable.

Exhibit 1 – Portfolio DCA Advantage and Cumulative Statistics

3-1

Of course, this 14 year period is just an example and is not necessarily representative of a “typical” experience.  However, our conclusions from the previous post hold – Lump Sum should be the preferred investment method since markets (both stocks and bonds) have a strong upward bias.

While mathematically the case for Lump Sum is fairly clear, there are other factors affecting these decisions:

  • Psychological / behavioral – it’s a hard thing to commit a large sum into the market all at once.  There is certainly no shortage of headlines to keep investors nervous – Government Shutdown, Taper, Sequestration, Debt Ceiling, Syria, Obamacare to name just a few.  Most of these come and go without any lasting impact on the markets.
  • Waiting for a pullback – this is very common and can drive you crazy.  Recently, the market keeps making new highs and investors feel like it “has to” pull back.  So they wait and wait, then get frustrated and pull the trigger at the worst moment.  Or when the pullback finally comes, it’s usually on the back of some disturbing news (see above) and few people actually take advantage of the opportunity to buy into the weakness.
  • Business risk for financial advisors – it’s a hard thing to explain to a new client how your portfolio started out with a million and dropped to $800,000 in a few months due to inopportune timing.  Not many advisors will admit to this, but using dollar-cost averaging is a “safer” approach for retaining new clients.

I follow a few simple rules to remain consistent and avoid frustration:

  • If the money was invested before (401k rollover, advisor change, etc.), I put it right back in the market
  • If it’s “new” cash (business sale, inheritance, etc.), I typically come up with a DCA schedule.  This can take anywhere from 3 to 12 months to get fully invested.  The timeframe depends on:
    • Current market position – this one is subjective and tricky
    • The amount involved relative to overall portfolio
    • Frequency of the event – a one-off business sale vs. annual cash bonus

At the end of the day, you have to do what will get you invested.  If it takes using dollar-cost averaging so be it.

One final thought: if you chose do DCA, set a schedule and stick to it.  Do not get cute and try to time each little investment you make.  It’s going to drive you crazy and you won’t do any better than following a pre-defined plan.

Related articles
  • To DCA or not to DCA: that is the question (planbynumbers.wordpress.com)

Share this:

  • Facebook
  • LinkedIn
  • Twitter
  • Pocket
  • Email

Sign up to the newsletter

Categories

  • Bear Markets
  • Bonds
  • Economy
  • Education
  • Financial Planning
  • Indexing
  • Investing
  • IPO
  • Retirement
  • Taxes
  • Uncategorized
  • Valuation

Archives

  • January 2023
  • October 2022
  • September 2022
  • August 2022
  • July 2022
  • May 2022
  • April 2022
  • February 2022
  • January 2022
  • October 2021
  • September 2021
  • July 2021
  • February 2021
  • January 2021
  • November 2020
  • October 2020
  • September 2020
  • July 2020
  • June 2020
  • May 2020
  • March 2020
  • February 2020
  • January 2020
  • November 2019
  • October 2019
  • September 2019
  • July 2019
  • May 2019
  • February 2019
  • January 2019
  • December 2018
  • October 2018
  • September 2018
  • July 2018
  • June 2018
  • May 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • October 2013
About
  • Background
  • Who We Are
  • The Gordian Knot
Services
  • Services
  • Planning Process
  • Investment Philosophy
Contact
  • Contact Details
  • Inquiry Form
  • Map
Media
  • Articles
  • Blog
  • Reviews
Dave
Denis
 
 
 
 

Gordian Advisors Financial Planner

Office: 2200 E. River Rd., Suite 109, Tucson, AZ 85718

Phone: 520-615-2779

Email: info@gordianadvisors.com

Download Form Form CRS Client Relationship Summary

Download Form ADV Disclosure Brochure

Gordian Advisors may only transact business or render personalized investment advice in those states where we are registered, or have filed notice, or are otherwise excluded or exempted from registration requirements. Material discussed is meant for general illustration and/or informational purposes only, and is not to be construed as investment advice. Nothing on this web-site should be interpreted to state or imply that past results are an indication of future performance. Although this information has been gathered from sources believed to be reliable, please note that individual situations may vary. Therefore, any information should be relied upon only when coordinated with individual professional advice.