In Defense of Dollar Cost Averaging

We are often faced with the perennial question of when to invest from clients – in bull markets and bear markets alike. Alas, given the difficulty (or impossibility?) and also the futility of timing the market, especially for those with long investment horizons, there is never an easy answer. The Indian mutual fund industry has popularised the systematic investment plan (periodic – monthly/quarterly investment of a fixed sum of money) or what is popularly known as dollar cost averaging (DCA) in the west to address this problem. However, as Nick Maggiulli puts it in this blog, investors often miscontextualise the application of DCA.
“There are two commonly used definitions for the term dollar cost averaging: (1) Investing money over time as soon as you have it (i.e., buying in your 401k every 2 weeks), and (2) slowly investing a large amount of cash. This post refers to definition (1). I generally disagree with definition (2) and have thoroughly debunked this style of investing here and in my book.”
What Nick shows in the blog with the link above is that if you are sitting on a pile of cash, you are better off deploying it in a lumpsum than trying to dollar cost average. However, if you have periodic cashflows (regular savings from salary or business profits), you are better off deploying it regularly as soon as you incur them as opposed to letting them accumulate in your savings or checking account or even temporarily parking them in a fixed deposit or bond funds as long as that saving was meant for long term wealth creation (and not a contingency fund or saving for a short term liability such as house purchase or funding your child’s education). He uses ‘the worst period in stock market history’, a period many fear currently given the common factor of sustained high inflation, to prove his point:
“…the mid 1960s to the early 1980s were a difficult time to be a U.S. stock investor…let’s examine how they would have performed if we invested $100 per month over this time period:
As you can see, an investor buying over time would have turned their $20,100 in investments (201 months * $100) into $41,629 by October 1982. However, this doesn’t adjust for inflation.
After doing so, our $20,100 in investments would have been worth $20,931 (in real terms) by October 1982:
As you can see, buying U.S. stocks over this time period would have kept pace with inflation. Think about that. During one of the darkest periods in U.S. stock market history, an investor who bought every single month at least preserved their purchasing power!
Of course, we don’t only want to preserve our purchasing power. We want to see our wealth grow. But consider the tradeoff here. When things go well for U.S. stocks, you build enormous amounts of wealth. And when they go poorly, you at least preserve your purchasing power. What’s not to like?
Well, the volatility. This raises the question: Would you have been better off had you been invested in a less volatile asset class instead of U.S. stocks over this time period? Let’s see.
…As you probably already know, sitting in cash (and not earning interest) isn’t a great move when inflation is high (as it was throughout most of the 1970s). In fact, if you had saved $100 a month and left it under your mattress from February 1966 to October 1982, your $20,100 in total savings would have only been worth $11,146 (in 1966 dollars) by the end of the time period. That’s a 45% decline in purchasing power due to sitting in cash.
Visually, you can see this (below) by imagining what a $100 payment would have grown to by October 1982 if it had been invested in the S&P 500 or cash. Note that in the chart below, the bars for cash are in front of the bars for the S&P 500 to make it easier to compare their growth over time.
For example, $100 invested in the S&P 500 in February 1966 would have been worth $94.67 by October 1982 (see first blue bar on the far left). However, if that $100 had sat in cash instead, it would have only been worth $32.59 by October 1982
As you can see, in every month pictured, a $100 in cash would have underperformed $100 invested into the S&P 500.
What about U.S. bonds? They basically keep up with U.S. stocks over this time period, however, they experience far less volatility while doing so. You can see this in the chart below which plots a $100 monthly investment into U.S. bonds (i.e. 5-Year U.S. Treasuries) and U.S. stocks (i.e. the S&P 500) over this time period
As you can see, owning U.S. bonds (5YR Treasuries) over this time period would have been a much smoother ride than owning U.S. stocks. While this might seem like I am making a case for investing in U.S. bonds, it’s actually the opposite.
Because, despite having similar performance with lower volatility, this is one of the few periods in history where U.S. bonds kept pace with U.S. stocks over such a long time. Most of the time the opposite is true. As I stated here:
If you had picked a random month to start buying U.S. stocks and kept buying for the rest of the decade, there is a 83% chance that you would have beaten 5-Year Treasuries.
Since U.S. bonds tend to underperform U.S. stocks (and by a lot), the fact that they kept pace with U.S. stocks from February 1966 to October 1982 isn’t much of a selling point for them.
However, it is a selling point for buying U.S. stocks over time. Because if U.S. stocks can keep up with (and sometimes exceed) the performance of less volatile assets during their worst times, think about how well they do during their best times.”

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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.