“Dollar cost averaging” is a fancy term for a simple concept. It’s the idea of investing a set amount of money at regular intervals, usually in individual stocks or a mutual fund, regardless of where the markets might be heading.
Many of us follow the strategy, particularly when we’re able to invest money from a regular paycheck using pre-tax dollars. I’ve done so for years.
However, each month when the statement comes, I tend to just look at how my overall investments have fared. Check the number, then toss the statement in a drawer. (From late-2008 through mid-2009, many statements weren’t even opened)
After more than a dozen years of following the concept of DCA, I finally decided to sit down with a calculator and crunch the numbers: Does it really work?
I picked a widely held mutual fund and tracked how it traded on the first trading day of the month. (For the record, it was hardly a scientific approach. I did not factor in possible dividends. And of course this was just one of countless mutual funds on the market today.)
I put in a hypothetical annual investment of $3000.
- To dollar-cost average, I invested $250 on the first trading day of each month. I tallied up the number of shares purchased.
Here’s how it fared after three years: Dollar-cost inched out a random approach by $35.
1. Dollar-Cost Averaging – 154.93 shares totaling $9,148
How about five years? Things changed. Looking back over historical figures since 2005, the lump sum strategy took the lead, albeit by about $45 over DCA.
1. Lump Sum Investing – 250.85 shares totaling $14,812
Now I was really curious. I took it back to 2003 (at this point my desk was littered with Excel spreadsheets and my calculator was asking for a break)
After seven years, the lump sum approach still held the lead, now by $463. Dollar-cost averaging was second. The random approach finished third.
1. Lump Sum Investing – 387.98 shares totaling $22,910
The findings turned my investing brain into mush.
Then I took a step back, and looked at the two years over the past decade where fear and volatility entered into the equation – points when an investor would be most inclined to hold off on investing, or to panic and simply hit the sell button.
As Puru Saxena, puts it “Markets have been run based on greed and fear for centuries, and they will continue to be run on greed and fear for centuries to come. If you want to keep your emotions out of the game, then investing in a disciplined manner on a monthly or quarterly basis is the best option for most people.”
In 2001 and 2008, dollar-cost averaging outperformed the lump sum approach, and it wasn’t close. (In 2001, the dollar-cost approach saw declines of 17 percent while the lump sum strategy fell 20 percent. In 2008, it was 23 percent versus 36 percent.)
And that’s why many advisors point to the dollar-cost approach in the long run. It takes fear and greed out of the equation. It can help prevent investors from making the all too common mistake of buying high, and selling low.
We’ve all heard the old tale that if you invested $10,000 in Microsoft when the company went public in 1986, today you’d be a multi-millionaire. We think back to when oil was trading at $30 a barrel, and ask ourselves why we didn’t get into the action. Or, look at the price of gold. Why didn’t I invest a bit just a few weeks back? We kick ourselves.
But actually making these investments is of course easier said than done. Because when we’re faced with investment decisions, it’s not that simple. People are comfortable with different levels of risk. And finding out where you stand within that spectrum can be challenging.
On this week’s Biz Clinic, we sampled a series of these tests designed to gauge your stomach for risk.
The following are some from a test put together by professor at Rutgers University:
In general, how would your best friend describe you as a risk taker?
You are on a TV game show and can choose one of the following. Which would you take?
When you think of the word "risk" which of the following words comes to mind first?
Take the full test if you want to get a clear picture of your appetite for risk.
While I was skeptical, the tests can be helpful. One independent consumer survey broke down a possible investment strategy for me. Another suggested a mix of aggressive mutual funds, with bonds. I was told I had a “moderate risk tolerance.”
They helped put my level of risk in perspective. And they got me thinking of another question you might ponder:
A Harvard-dropout has started a relatively new company that could revolutionize the way people use personal computers. You could make millions in the long run. But right now, he needs $10,000. Would you fork over the cash?
When most people think of their own budgets, they think of money on a relatively simple scale; food, housing, transportation, household goods and so forth.
I’ve moved several times over the past several years. With each move I track my spending to gauge my new cost of living. It’s nothing complex. I simply jot down how much I spend each day on things like lunch, groceries and transportation. After a few weeks, it’s easy to see where I stand.
That’s because the numbers are simple.
But then you hear the staggering figures batted around over the past year. Whether it’s millions of dollars for Wall Street bonuses, or billions of dollars in bankruptcy filings, it all starts to turn into a blur of huge sums.
Then, as if those figures aren’t confusing enough, the White House comes along and projects a $9 trillion budget deficit over the next 10 years.
How does a person even get their mind around such a massive sum of money?
Nine trillion is nine million million dollars.
Sorry, did that just make things more confusing? Maybe these three points might help put it all in perspective:
- If you spent ten million dollars a day, every single day going back to the year Christ was born, you would have only spent about $7.3 trillion by now.
- As Temple University Professor John Allen Paulos pointed out to CNN a few months back, “A million seconds is about 11½ days. A billion seconds is about 32 years, and a trillion seconds is 32,000 years."
- Or as Colleen McEdwards found in this week’s Biz Clinic, if you stacked one dollar bills one on top of the other, the pile could go to the Moon and back … then halfway back to the Moon.
And if each of the roughly 300 million Americans chipped in to payoff a $9 trillion deficit, we’d each have to shell out $30,000.
I don’t know about you, but that’s just not in my budget.
HONG KONG, China – The Hang Seng is up 80 percent since March. Hong Kong recently emerged from the recession. And in this volatile housing market, property prices here - always a closely watched indicator - are on the rise again.
Take a walk through one of Hong Kong’s sprawling malls, or try to fight your way through the congested stores in Causeway Bay, and it’s clear that shoppers are out in force.
Many are holding the view that the worst is over. They might be right.
But Stephen Roach, chairman of Morgan Stanley Asia, says caution is still the key. In a chat with Biz Clinic, Roach gives his views on where things stand.
The markets: The markets are “a lot stronger than the underlying state of the global economy,” says Roach, who previously was chief global economist for Morgan Stanley for more than 15 years. That will raise some real risks for equities in the second half of this year.
It’s important to remember that as much as 75 percent of the world’s economy has been contracting, and the American consumer remains “dead in the water” right now, Roach says. “When markets go up, memories get short.”
The housing myth: The focus on the U.S. housing market is “overblown,” Roach says. In his view, the damage has already been done. And even if housing does stabilize, consumers are still “stuck with too much debt on overvalued homes,” he says. “And now they’re stuck with job and income problems on top of that.”
Shooting down ‘green shoots’: It’s been the catch phrase of the recovery, but Roach shrugs off the idea of so-called “green shoots.” “(It’s a) fiction that’s been woven around liquidity driven markets,” he says, and the current “green shoots” will not blossom into large plants or bushes.
Keys to recovery: Here is what needs to happen for a global recovery, according to Roach :
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