Does Dollar Cost Averaging Work?

Dollar cost averaging means investing a fixed amount at fixed intervals of time. That's a sensible approach, for example, if it means committing yourself to investing a fixed amount of your salary every month toward your retirement.

However, some people also think you should dollar cost average a lump sum. For example, if you had \$12,000 that you wanted to invest in a stock index fund, they would tell you to invest \$1000 per month over a year, rather than investing the whole amount immediately. The rationale is that market volatility should then work in your favor, because you will automatically be purchasing more shares when the price is low, and fewer shares when the price is high.

As appealing as that theory is, its advantage looks like a myth, as this calculator shows. It uses market data to let you compare dollar cost averaging with lump sum investing for the start date you specify.

 Assumptions
\$10,000 will be invested in a market investment, following two different strategies:

 (a) the whole amount will be invested on the start date; and (b) equal amounts will be invested at the start of every month for a year, during which the remaining cash will stay invested in a bank account at a guaranteed interest rate.

The market investment is an S&P 500 index fund with annual fees of 0.2%.

The bank account interest rate is %

 Select Start Date
 January February March April May June July August September October November December 2000
 Results
Investment Value After 12 Months
(a) Using Lump Sum Method: \$
(b) Using Dollar Cost Averaging: \$

Each strategy wins at least some of the time, but after a few runs you'll see that DCA is the statistical "dog", losing about two times out of three.

Of course, dollar cost averaging will win if your start date falls right before a dramatic crash (like October 1987) or at the start of an overall 12 month slump (like most of 2000). But unless you can predict these downturns ahead of time, you have no scientific reason to believe that dollar cost averaging will give you an advantage.

So why do so many people persist in believing that this old dog really knows how to hunt? Maybe because it has a psychological appeal: if the market dips, people will be happy because DCA will be saving them money; and if the market goes up, people will be happy regardless.

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