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Dollar cost averaging works when you have a steady stream of income that you're contributing to your investments and you have a heavily diversified portfolio.

by zhdc1 4y ago

Dollar cost averaging works when you have a steady stream of income that you're contributing to your investments and you have a heavily diversified portfolio. The reason being that, over a 5+ year investment horizon, a total US market portfolio will average about 6% after inflation. However, going off of empirics, dollar cost averaging is less preferable when you have a single lump sum. While it's possible that you 'time' the market wrong with your investment, the odds that you'll happen to invest immediately before a sharp down turn are lower than the odds that you'll miss out of rather significant gains by not being invested. This all assumes that you have a diversified portfolio. If you're trying to invest in single stocks, good luck.

senko 4y ago
> dollar cost averaging is less preferable when you have a single lump sum This is mathematically true. Psychologically less so, and that's because of loss aversion. DCA helps you avoid the unfortunate case where the market tanks right after you've invested everything. In this situation, people can panic, pull out at considerable loss, etc. As a retail investor, the most challenging part of investing is psychology, and DCA can help in that regard.
- zhdc1 4y ago
  > As a retail investor, the most challenging part of investing is psychology, and DCA can help in that regard. Agree 100%.
time_to_smile 4y ago
> a total US market portfolio *will* average about 6% after inflation. has and will are very different claims when applied to market behavior. Yes the US (and global) economy has been in an incredible period of overall growth for many decades. We've had particularly insane growth in the last few years. But I see no evidence that anyone in their right mind should expect that growth to continue indefinitely. People believe that bear markets are basically a season in the contemporary market place, but there is no reason that cannot be the long term trend. Across the board we're seeing resource and energy constraints. For every individual asset people are well aware that "past performance does not indicate future returns" but somehow when we consider the combination of all assets we forget all about that.
- rr888 4y ago
  As a non-American I can't believe how much faith people put in the stock market here. I think they're going to be a rude shock the next few decades.
  - zhdc1 4y ago
    The underlying issue with "saving" is that the monetary system is setup in a way that forces you to invest in productive assets. Cash, as a store of value, is awful. You're guaranteed to lose 2-3% a year. The question becomes what, exactly, can you do with cash. In countries where most or all industries are at their or near their productivity frontiers, you have two options. You either try to push the productivity frontier out and capture as much of the resulting value as you can, or you "lend" your assets to other people or groups of people who are attempting to do so. The issue with either option is that innovation is inherently difficult. Failure is a real possibility and success generally requires a sustained level of effort. The benefit that the second option gives you is the opportunity to place a large number of bets without having to also actively engage in the actual innovation. That is, you have the opportunity to passively invest in a diversified portfolio. Now, if you take the second option, the question becomes how, exactly, do you invest. There are a couple of different options here. First, you can invest in an organization that captures rents from all of the economic activity according to some criteria. This is what you do when you invest in government bonds. You're essentially placing a bet that tax revenue will grow over time, which itself is a bet that - all else being equal - the economic activity of all of the individuals and companies that pay taxes will also grow over that period of time. Second, you can attempt to purchase individual assets. Here you're making a directional bet that the value produced by that asset will grow over time. Real estate falls into this category (although real estate is by no means passive), as do corporate bonds and stocks. The issue with this option is that the distribution of companies that successfully create additional economic value is extremely skewed. A small number of companies succeed. Those that succeed generally don't continue to do so over time. The rest either tread water or go out of business. Now, the other issue is that there is little to no evidence that individuals are able to successfully pick in advance which companies will actually to generate additional economic value - before - others do so. That is, it's extremely difficult to outperform the market. Third, you can invest in a large number of companies according to some screen or criteria. This is essentially what you're doing when you invest in a total market fund. That is, knowing that a large number of organizations are trying to expand their productivity frontiers and that most of them will either fail to innovate or capture the resulting value, you 1. eliminate those that are most likely to fail and 2. place a bet that some percentage of the remaining companies will succeed. This approach has historically produced returns of around 6% in the United States. > As a non-American I can't believe how much faith people put in the stock market here. I think they're going to be a rude shock the next few decades. Going back to my original point, money is a bad store of value. Given that almost all investable assets (including government debt) are somehow tied to economic growth, it's just a question of where in the value chain do you want to place your bets, and do you feel that you're competent enough to successfully place directional bets on individual assets (evidence shows that, without active involvement, this is essentially a loser's bet). You have to invest in something. The question is, what, exactly, are you going to invest in?
turndownsideup 4y ago
Lump sum broken up in increments is a very simple portfolio of cash and equities. There is opportunity cost of the cash (inflation is 9% currently). These don't compare the same as apple and oranges. Mathematically, as long as equity value is always accretive (due to passive flow from pensions) lump sum does win on a raw return basis. This doesn't take account of drawdown management. (Think 3AC)
teraflop 4y ago
> The reason being that, over a 5+ year investment horizon, a total US market portfolio will average about 6% after inflation. Leaving aside the issue that past performance does not guarantee future performance: If you're talking about "averages" based on historical data, then the average annual return over a 5-year period is -- by definition -- the same as the average return per year. The investment horizon doesn't affect the average expected return, but it does affect the dispersion of outcomes around that average. I think it's a bit irresponsible to say that a 5-year investment "will average" 6%, when the standard deviation of that number is something like 8-10%. Seeing negative real returns over 5 year periods isn't just a theoretical possibility; it's historically fairly common.
deleted 4y ago
[deleted]
ASinclair 4y ago
> Dollar cost averaging works when you have a steady stream of income that you're contributing to your investments and you have a heavily diversified portfolio. To be pedantic (this is Hacker News after all), that is not Dollar cost averaging. That's lump sum investing at a regular interval. Dollar cost averaging assumes you start with a pot of money and you choose to invest fractions of that initial pot over time. This is opposed to lump sum investing in which you'd invest the full pot of money at the start.
- hinkley 4y ago
  This is unfortunately not how DCA was explained to me. If you had extra money during the dot-com boom, you were probably taught that investing $400 a month in a fixed set of commodities was dollar cost averaging. It was almost ten years later that I encountered the notion of portfolio rebalancing specifically mentioned in the context of DCA. Luckily I already had a notion that this might be a good idea, but how you behave when you know something is good is a bit different from how you behave when you suspect it is. I was not being as disciplined about it as I should be.
- JustSomeNobody 4y ago
  > Dollar cost averaging assumes you start with a pot of money and you choose to invest fractions of that initial pot over time. This is opposed to lump sum investing in which you'd invest the full pot of money at the start. How is this not the same as: > Dollar cost averaging works when you have a steady stream of income that you're contributing to your investments and you have a heavily diversified portfolio. My "pot of money" is my salary over the course of my career and my "investing fractions of that pot over time" is twice weekly contributions. Whether I start with the whole pot or not is of no consequence.
  - mbesto 4y ago
    > Whether I start with the whole pot or not is of no consequence. Do you get paid your salary a whole year in advance? No. Thus this distinction is important. As noted in the wikipedia article above the rationale for this has to do with "I have a big load of cash right now, do I just put all of it to work now or slowly over time?"
MuffinFlavored 4y ago
> The reason being that, over a 5+ year investment horizon, a total US market portfolio will average about 6% after inflation. I see a lot of talk lately how if the Federal Reserve needs to get the "Federal Funds Effective Rate" to a "not artificially 0-2% low" (like we've had for a while due to various forms of quantitative easing) that stock returns of typical "6% after inflation" with dividends reinvested aren't as likely. Any thoughts? https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS

by zhdc1 4y ago

senko 4y ago

> dollar cost averaging is less preferable when you have a single lump sum This is mathematically true. Psychologically less so, and that's because of loss aversion. DCA helps you avoid the unfortunate case where the market tanks right after you've invested everything. In this situation, people can panic, pull out at considerable loss, etc. As a retail investor, the most challenging part of investing is psychology, and DCA can help in that regard.

zhdc1 4y ago
> As a retail investor, the most challenging part of investing is psychology, and DCA can help in that regard. Agree 100%.

time_to_smile 4y ago

> a total US market portfolio *will* average about 6% after inflation. has and will are very different claims when applied to market behavior. Yes the US (and global) economy has been in an incredible period of overall growth for many decades. We've had particularly insane growth in the last few years. But I see no evidence that anyone in their right mind should expect that growth to continue indefinitely. People believe that bear markets are basically a season in the contemporary market place, but there is no reason that cannot be the long term trend. Across the board we're seeing resource and energy constraints. For every individual asset people are well aware that "past performance does not indicate future returns" but somehow when we consider the combination of all assets we forget all about that.

rr888 4y ago
As a non-American I can't believe how much faith people put in the stock market here. I think they're going to be a rude shock the next few decades.
- zhdc1 4y ago
  The underlying issue with "saving" is that the monetary system is setup in a way that forces you to invest in productive assets. Cash, as a store of value, is awful. You're guaranteed to lose 2-3% a year. The question becomes what, exactly, can you do with cash. In countries where most or all industries are at their or near their productivity frontiers, you have two options. You either try to push the productivity frontier out and capture as much of the resulting value as you can, or you "lend" your assets to other people or groups of people who are attempting to do so. The issue with either option is that innovation is inherently difficult. Failure is a real possibility and success generally requires a sustained level of effort. The benefit that the second option gives you is the opportunity to place a large number of bets without having to also actively engage in the actual innovation. That is, you have the opportunity to passively invest in a diversified portfolio. Now, if you take the second option, the question becomes how, exactly, do you invest. There are a couple of different options here. First, you can invest in an organization that captures rents from all of the economic activity according to some criteria. This is what you do when you invest in government bonds. You're essentially placing a bet that tax revenue will grow over time, which itself is a bet that - all else being equal - the economic activity of all of the individuals and companies that pay taxes will also grow over that period of time. Second, you can attempt to purchase individual assets. Here you're making a directional bet that the value produced by that asset will grow over time. Real estate falls into this category (although real estate is by no means passive), as do corporate bonds and stocks. The issue with this option is that the distribution of companies that successfully create additional economic value is extremely skewed. A small number of companies succeed. Those that succeed generally don't continue to do so over time. The rest either tread water or go out of business. Now, the other issue is that there is little to no evidence that individuals are able to successfully pick in advance which companies will actually to generate additional economic value - before - others do so. That is, it's extremely difficult to outperform the market. Third, you can invest in a large number of companies according to some screen or criteria. This is essentially what you're doing when you invest in a total market fund. That is, knowing that a large number of organizations are trying to expand their productivity frontiers and that most of them will either fail to innovate or capture the resulting value, you 1. eliminate those that are most likely to fail and 2. place a bet that some percentage of the remaining companies will succeed. This approach has historically produced returns of around 6% in the United States. > As a non-American I can't believe how much faith people put in the stock market here. I think they're going to be a rude shock the next few decades. Going back to my original point, money is a bad store of value. Given that almost all investable assets (including government debt) are somehow tied to economic growth, it's just a question of where in the value chain do you want to place your bets, and do you feel that you're competent enough to successfully place directional bets on individual assets (evidence shows that, without active involvement, this is essentially a loser's bet). You have to invest in something. The question is, what, exactly, are you going to invest in?

turndownsideup 4y ago

Lump sum broken up in increments is a very simple portfolio of cash and equities. There is opportunity cost of the cash (inflation is 9% currently). These don't compare the same as apple and oranges. Mathematically, as long as equity value is always accretive (due to passive flow from pensions) lump sum does win on a raw return basis. This doesn't take account of drawdown management. (Think 3AC)

teraflop 4y ago

> The reason being that, over a 5+ year investment horizon, a total US market portfolio will average about 6% after inflation. Leaving aside the issue that past performance does not guarantee future performance: If you're talking about "averages" based on historical data, then the average annual return over a 5-year period is -- by definition -- the same as the average return per year. The investment horizon doesn't affect the average expected return, but it does affect the dispersion of outcomes around that average. I think it's a bit irresponsible to say that a 5-year investment "will average" 6%, when the standard deviation of that number is something like 8-10%. Seeing negative real returns over 5 year periods isn't just a theoretical possibility; it's historically fairly common.

deleted 4y ago

[deleted]

ASinclair 4y ago

> Dollar cost averaging works when you have a steady stream of income that you're contributing to your investments and you have a heavily diversified portfolio. To be pedantic (this is Hacker News after all), that is not Dollar cost averaging. That's lump sum investing at a regular interval. Dollar cost averaging assumes you start with a pot of money and you choose to invest fractions of that initial pot over time. This is opposed to lump sum investing in which you'd invest the full pot of money at the start.

hinkley 4y ago
This is unfortunately not how DCA was explained to me. If you had extra money during the dot-com boom, you were probably taught that investing $400 a month in a fixed set of commodities was dollar cost averaging. It was almost ten years later that I encountered the notion of portfolio rebalancing specifically mentioned in the context of DCA. Luckily I already had a notion that this might be a good idea, but how you behave when you know something is good is a bit different from how you behave when you suspect it is. I was not being as disciplined about it as I should be.
JustSomeNobody 4y ago
> Dollar cost averaging assumes you start with a pot of money and you choose to invest fractions of that initial pot over time. This is opposed to lump sum investing in which you'd invest the full pot of money at the start. How is this not the same as: > Dollar cost averaging works when you have a steady stream of income that you're contributing to your investments and you have a heavily diversified portfolio. My "pot of money" is my salary over the course of my career and my "investing fractions of that pot over time" is twice weekly contributions. Whether I start with the whole pot or not is of no consequence.
- mbesto 4y ago
  > Whether I start with the whole pot or not is of no consequence. Do you get paid your salary a whole year in advance? No. Thus this distinction is important. As noted in the wikipedia article above the rationale for this has to do with "I have a big load of cash right now, do I just put all of it to work now or slowly over time?"

MuffinFlavored 4y ago

> The reason being that, over a 5+ year investment horizon, a total US market portfolio will average about 6% after inflation. I see a lot of talk lately how if the Federal Reserve needs to get the "Federal Funds Effective Rate" to a "not artificially 0-2% low" (like we've had for a while due to various forms of quantitative easing) that stock returns of typical "6% after inflation" with dividends reinvested aren't as likely. Any thoughts? https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS