What Is Dollar-Cost Averaging And Why Is It Bunk?

Dollar cost averaging (DCA) is a method of investing whereby you spend a fixed amount on a stock per month, regardless of price.

According to its proponents, which include School House Rock, this reduces your risk because you buy less of a stock when it’s high, and more when it’s low.

DCA was debunked, using scary equations, in,”A Note On The Subotimality of Dollar-Cost Averaging As An Investment Policy” published in the Journal of Financial and Quantitative Analysis in 1979 *. Comparing DCA to lump-sum, George Constantindies wrote, “Both investors face the same prospects irrespective of the composition of their endowment, and any claims of gambles on temporarily overpriced or underpriced prices are simply fallacious.”

Statistically, DCA underperforms lump-sum investing (aka, putting a buncha money in at once), as this calculator shows. An exercise by MSN Money found that DCA even underperforms putting in money at random intervals. Their rate of return was 9.8% for DCA, 10.5% by happenstance, and 11.7% with a lump-sum.

However, there is a method that fares even worse than DCA: not investing at all. — BEN POPKEN


* From A Note On The Subotimality of Dollar-Cost Averaging As An Investment Policy:

Where, then, does the intuitive rational of DCA fail? Its rationale is that the investor replaces one major gamble on a temporary shift of prices by a number of smaller gambles and thus diversifies risk. The fault of this argument is misrepresentation of the state of the world, before a decision is made. DCA implies than an investor with all his endowment in asset A is in some way different from an investor with all his endowment in asset B, but otherwise identical. DCA ignores the simple fact that the latter investor may costlessly convert his endowment from asset A to asset B before he considers the optimal investment decision. Both investors face the same prospects irrespective of the composition of their endowment, and any claims of gambles on temporarily overpriced or underpriced prices are simply fallacious. We do not claim that the investor should not incorporate in his optimal decision his beliefs on whether assets are overpriced or underpriced. What we do claim is that these beliefs lead to the same optimal portfolio irrespective of the composition of initial wealth.