What is the Performance of Dollars Cost Averaging?
My friend said DCA is a myth. Let’s rewind the time clock back 50 yrs. Let’s say you invest $5K (inflation adjusted each yr) inside an index fund which replicated the Dow Jones avg. You invest the regardless of the market. You don’t sell a single share. What would be your average anual return be??
It’s an interesting question because it will depend on the market environment.
DCA will underperform in upward trending markets, but in markets with volatility, it will outpeform. Over the really long term, the volatility factor has outweighed the upward trending tendency of the markets, though really since mid-century, the upward trend has been so pronounced that it outweighs the volatility.
By way of example, I found a site where you can get closing prices for the Dow Jones, and got yearly data all the way back to 1915. The link is below. From those closing values, I calculated annual returns.
From my calculations, it appears that depositing $5000 per year (for a total of 465,000) would have resulted in an ending value of $7,248,932. If, instead, you had taken the entire 465,000 and invested it as a lump sum in 1915, your ending value would have been $6,066,909
So it appears that, at least from the period of 1/1/1915-1/1/2007, which includes the great depression, a couple of world wars, and a tech boom, DCA is the better choice.
If, however, we look at just the last 50 years of data, it’s a different picture. DCA would have left you with 1,661,500 and just investing a lump sum of 250,000 at the beginning of the period would have left you with 3,801,810.
Of course, it’s worth mentioning that the DCA side of these calculations assumes that you aren’t earning anything on the univested portion of the cash. If you assume that you could get the risk free rate on the uninvested balance then the DCA calculations would be somewhat higher.
So it’s a question of forecasting. If you believe that volatility is the dominant factor, DCA is the way to go. If you believe in expansion without bounds, (and if you have a lump sum to invest) lump sum investing will be preferable.
As always in finance, the answer is: “It Depends”
