Dollar Cost Averaging Myths
Dollar cost averaging (DCA) seems to be a hot topic of late with many experts saying to continue buying shares, even as they keep falling in price. For those of you who may not understand DCA, it basically means that you continue to buy more shares in companies that you already own as they fall away in price in order to achieve a lower average purchase price. Now I don’t know about you, but I struggle to understand why anyone would want to buy shares in an asset that is falling. Particularly if they can afford to earn more money in other, more stable investments such as corporate or municipal bonds.
If you had dollar cost averaged into well known and widely held companies like General Electric (GE), Citibank (C) or Microsoft (MSFT) over the past 6 months, thinking they had bottomed earlier in the year, you would most certainly be questioning whether this was wise given that shares in these companies continued to fall throughout the year. Similarly, those who employed the dollar cost averaging strategy for many financial or technology companies or ETF's thinking they had also bottomed mid-year would still be regretting their decision as they could have made (or avoided losing) far more money during this time.
In my opinion, and owing to current market conditions, dollar cost averaging or buying shares as they fall away because they seem "cheap", is not smart investing for the simple reason that most investors do not know where the bottom is and to buy without knowing is speculating. I have evened questioned the current benefits of dollar cost averaging in 401K/retirement accounts (per this post) for the same reason as above, we don’t know when the market will bottom and it seems like stocks still have a long way to fall.
So why not wait till things stabilize and get a much larger amount of stock at a lower price, rather than smaller amounts at higher prices. You may not pick the exact market bottom, but you will definitely be better off than buying a stock that continues to fall. Only when the market stabilizes and resumes normal behavior, will dollar cost averaging become a "smarter" investing move.
Related Posts:
~ Capital Gains and Losses : Tax Facts and Figures
~ Global Stock Markets Performance in 2008
~ Stock Market Volatility - Now is NOT the Time to Sell
Liked what you read? Then consider subscribing (free) to get the latest articles delivered directly via RSS or Email
January 7, 2009 10:33 AM
I agree. "it seems like stocks still have a long way to fall"
That is reason enough to stop buying.
January 7, 2009 11:01 AM
If you *know* stocks are going to fall, of course you shouldn't buy them.
But with respect if you *know* stocks are going to fall, you shouldn't be blogging - you should be working on Wall Street. :)
One day this bear market will be over and people who are too cautious will be left on the sidelines.
Today, tomorrow, who knows? The markets have already bounced 10-20% around the world. My emerging market fund is up over 25%.
Dollar cost averaging is a way of getting a reasonable result, at the cost of the *best* result.
Keep up the great blog! :)
January 7, 2009 7:28 PM
@ Monevator - Thanks for the comment. I am not oracle, but I do know that economic conditions are not going to improve much in 2009 so it is more likely than not that shares will fall or stay flat. I am not staying do not invest, I just think that DCA is not the right stragegy at the current time. Also, I do work on Wall street :). DCA is a good strategy in normal markets, but there is still a lot of bad news to unfold.
The bear market will be over, I agree someday. That is why you must be tactical with your investments and get in at the right time. One the January effect is over, Feb/mar are likely to be horrible months. Normally the stock markets is 6 months ahead of the economy in terms of reacting to bad news. So if things start improving in 2010, then mid 2009 would be time to get in.
DCA only works over the long term once capital appreciation retuns. Right now, deflation (of assets) is a bigger concern. There is no need to "automatically" invest in the market via DCA. Patience and waiting for a better price is more prudent.
But hey I could be wrong and you could be spot on. That's what I love about blogging, everyone can have their opnion and I respect your perspective (and your blog!)
Cheers,
Andy
January 7, 2009 10:19 PM
Nice article. May I invite you to my blog entitled "Millionaire Acts" with URL: http://www.millionaireacts.com
January 8, 2009 1:14 AM
Andy: What you say makes sense but how do we tell when markets are "stabilized" and return to "normal"? Do we even know what "normal" is any more?
January 8, 2009 1:54 AM
I agree with Monevator. Stocks have already rebounded a great deal. If you're sitting around waiting, you already missed a huge uptick. I'm not necessarily a big fan of DCA, but just sitting around "waiting" is a form of market timing.
There are numerous studies that show that by missing just a few days when the market rallies (which usually occur soon after a huge drop), you lower your return by numerous percentage points. By waiting to get back into the market, you're not buying low.
Stocks do not necessarily follow the economy. The last number of recessions show that the stock market improves well before the GDP (measure of the economy) does (as you mention).
You claim not to be an oracle, but then claim that you "know" that economic conditions are not going to improve in 2009, that "there is still a lot of bad news to unfold", and that mid 2009 is the "time to get in".
You could be completely correct, but by the same token you could be off on your forecast.
January 8, 2009 4:21 AM
@Andy - "I do work on Wall Street" - touche! ;)
Just to be clear I'm not saying stocks will definitely rebound in 2009. I'm saying there's every chance they will, just as there's every chance they will fall, and that missing the start of a bull market can be very costly.
Thanks for kind comment about my blog.
February 3, 2009 10:56 PM
hello i am self employed how is this so called tax cut going to help me. I wont see anything till i do my taxes in 2010. and that 500 dollars thing thats not going to help at all. i am a single mother of 2 kids we need a lot more help than 500. i was hoping it would be better than last year the way the president was taking but he ant helping the poor!!!!!!!!!
February 12, 2009 3:42 PM
My opinion is that there are so many people in Michigan who severely need financial help now and that the stimulus check last year did help alot of us play catch-up on our bills. We need help with money now. Of course people in Congress do not want to pass another Stimulus Check because they're worried of those checks taking money out of their pockets. I cannot understand why they have to be paid so much as our families and children are at the brink of being homeless and starving but as long as Congress has their wallets padded that good enough for them. This government makes me so sad all that matters to you all is your own behinds. What about my family? You people are killing us! Can't let your huge pay checks help us? We see commercials all the time about children starving in other countries but what about the children here in America who are homeless and starving and all of the people who are losing their homes? See when all of you talk to us about helping America I think you really need to mean it. And I haven't seen nothing that has lasted. I'm ashamed of this whole mess.