Tuesday, January 30, 2007

No Dollar Cost Averaging For Me, Thanks! (And Here's Why)

As I mentioned, my parents wrote me a lump-sum check for the money they're contributing to my life. I've already transfered 1/3 of that sum to my ING "travel" subaccount. It only remains to send the remaining 2/3 over to my Roth at Vanguard. But how to do it? In a big chunk or in regular smaller chunks?

For those of you new to investing: investing a big (or big-ish) chunk of money in smaller, regular increments is called "dollar-cost averaging." The idea is that by investing regularly, you guard yourself against the risks of buying anything at its peak and avoid the temptation to try to time the market.

To my mind, there are two major points against dollar-cost averaging:
1. Convenience
I can schedule automatic transfers from my checking account to the Roth--that's not a particularly big deal. But where would I hold the money that hasn't yet been transfered? No way I'm going to keep that money in my checking account, earning no interest while I wait to transfer it. I could, then, transfer it over to ING and let it earn 4.5% until I move it into the Roth--but that requires a lot more work: remembering to beat my scheduled transfer by several business days and transfering money from ING to Bank of America and waiting for the automatic ACH from Vanguard to hit. Irritating. One ACH transfer from my checking account to my Roth? Way easier.

2. Rate of return
Check out Google's three-month and six-month graphs of the target fund in which my Roth is fully vested. Look at the y-axis points (price) at which it crosses the x-axis unit marks (months). Each one is higher than the last: there is no point at which each month has brought net depreciation, which means each successive month, my regular investment would buy fewer shares. This is a graphic depiction of the points made by several recent posts and articles about the downsides of dollar-cost averaging, including this comprehensive but somewhat dense one and this convincing one from MSN Money. Even taking into consideration that my non-invested money would be earning 4.5%, it seems lump-sum investing beats dollar-cost averaging over 60% of the time. That article also points out that the times that dollar-cost averaging wins out are in periods spanning a major crash.

Both are important factors for me, and both point towards lump-sum investing as the way to go. That's what I'll be doing: initiating a transfer for the full amount from my checking to my Roth, and waiting for it to grow.

7 comments:

Wanda said...

Great post... I was considering how to invest my bonus, and now I think lump-sum may be the way to go.

mOOm said...

You certainly should transfer all the money into the Roth right away and get it over with (and avoid tax on interest). But I am sure that you have a money market alternative in there. So you can still DCA from a money market to a higher risk fund. On the one hand 6 months is way too small of a sample to make the judgment on volatility. On the other hand $3000 or whatever isn't much money. If someone was rolling over a much bigger account or selling a house and investing the proceeds or inheriting a pile of money then to DCA or not would be important. This year's $4000 contribution isn't much though. You get to do another contribution next year and that will be at a different price and that will give you DCA-ing anyway.... So, bottom line I guess I agree with your outcome if not the way you got there :)

Anonymous said...

I am a big time advocate of dollar cost averaging. Check out my article on dollar cost averaging automatically.

http://www.thetimeandmoneygroup.com/blog/2006/06/25/dollar-cost-averaging-automatically/

Personally, I believe lump sum investing can be costly without using technical indicators to determine if a stock or fund is overbought or oversold. In theory stocks go up over the long run, but depending on your timing you may have to wait a long time to see profits.

Anonymous said...

Lump-sum always beats DCA, assuming you already have the lump in hand.

DCA is an alternative to after-the-fact lump-sum investing, not prior.

moneymonk said...

To each it's own. Most do DCA because of cash flow.

I use lump sum in my ETFs, but for as individuals stocks I do dca.

Investing is better than not at all.

Anonymous said...

Great Article on DCA! After doing my own research, I fully agree with you and feel that lump sum should be the way to go. Too many people still think DCA is the way to "reduce risk" and even out volatile markets and equities.

Great blog you have going, and do check out my article on DCA and tell me what you think.

http://verylegal.110mb.com/articles/why-you-should-not-dollar-cost-average.html

Thanks for sharing your analysis and experiences!

Cheers,
verylegal

Anonymous said...

Great post... but I am not sure I agree with you. But that could also be because I don't want to play the market at all. I invest in mutual funds using DCA, and so far it has worked out beautifully. If I had a lump-sum I wanted to invest... I don't know how I would go about doing that. Plus, how do you time your investments?

But hey! whatever floats your boat.