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Over the past few days, we’ve been getting questions via email from people who have a bunch of money saved (yes, they DO exist), want to start investing but are concerned that the market’s too frothy (the Dow JUST hit a new all-time high last week), or Brexit/Donald Trump is just around the corner, and they’re not sure that now is the right time to enter the market.
And believe me, this is not a new debate. We went through this exact same thing when we were starting out. When it comes to picking an entry point in the stock market, the joke is that there are only two thoughts that investors have:
- Markets are going up too fast. I’d better wait.
- Markets are crashing. I’d better wait.
Heck, when we, in our infinite wisdom, decided to enter the market, we managed to pick the single worst possible time, September 2008, right on the eve of a the worst financial crisis and stock market crash we’re going to see in our lifetime. And yet we still managed to come out unscathed. How?
Dollar Cost Averaging.
Basically, Dollar Cost Averaging (or DCA, as the cool kids call it) is the idea that instead of deploying all your cash in one go, you space out your buys over time. For example, if you have $100k, instead of just buying $100k of ETFs (in whatever portfolio allocation you’ve decided), you split up your $100k into $25k slices, and deploy it in 4 separate buys every quarter. This way, you wade into the water over time instead of jumping in all at once.
Now, Dollar Cost Averaging is often maligned in the media because statistically, it’s been better to dump all your money into the market in one lump-sum buy as soon as you can. And you can find article after article showing this. This entire argument, however, is really harmful to people trying to figure out how to invest their money. Why?
Let’s examine where these statistics are coming from.
Here’s a typical chart of the performance of the S&P 500, from 1995 to 2000.
Charts like this are easy to find, because as we’ve written about before, the Indexes have historically gone up. In fact, over 15-year periods, the S&P500 has never lost money, so you can always find time periods that look like this chart. In this scenario, the right thing to do is obviously deploy all your cash at the beginning when the line is low, and then just let that bet ride. If you were to spread out your buy orders so that you’re buying an equal amount every month over the first two years, you would obviously underperform the lump-sum investment.
That’s the typical argument for not using Dollar Cost Averaging. However, let’s see what happens when the market’s aren’t behaving quite so nicely.
Here is the S&P500 from the not-so-fun period of 2008-2013.
That’s the crash of 2008 plus the uneven and rocky recovery finally ending in 2013. In this scenario, dollar cost averaging over the first 2 years would have resulted in buying units right into the storm. How does that work out?
Huh? What? I’ve outperformed the market?
Yupperinos. The beauty of Dollar Cost Averaging is that when you do it in a flat (or crashing) market, you end up picking up more units at a lower price. And because you’ve picked up more units, when the recovery happens you end up participating in the upside more strongly than the downside.
In fact, the scenario of spreading out your buys into monthly purchases over two years pretty closely mirrors what we actually did. And we’ve claimed before that despite the fact that the markets didn’t recover until 2013, we regained all our money by 2009. You can actually see that happening in this chart. Because we re-balanced our assets and continued piling in more money from our pay-checks even as markets crashed, we were essentially Dollar Cost Averaging, and that’s why we didn’t lose money in the Great Financial Crisis.
That being said, the whole debate about Dollar Cost Averaging vs Lump Sum Investing is stupid and irrelevant. For a typical person trying to save/invest in early retirement, it always makes sense to Dollar Cost Average.
Why? Well two reasons.
First, the Lump Sum argument has you being handed $100k all at once. In what real-life scenario does this actually happen? Normal people who don’t have the last name Kardashian don’t get randomly handed $100k checks. I didn’t. We worked normal jobs and got paid gradually over the year, usually in 2 week increments. So you naturally have to Dollar Cost Average anyway.
And secondly, even if you did get handed $100k and wanted to invest in a lump sum, think about how intimidating that would be. If you’re doing something for the first time, whether it’s investing, or scuba diving, or asking someone out on a date, if you’ve never done it before it’s terrifying. What typically happens in this scenario is the would-be investor starts reading articles, listening to financial pundits, staring at stock market charts and thinks “Oh God, is this the right time? What if it crashes? But what if it goes up and I miss out? Gaaaah!” And then they freak out and do nothing. This is known as analysis paralysis, and if you’ve ever procrastinated in doing something risky, you know what this feels like. It ain’t fun.
But what if our investor actually does close his eyes and hit the buy button? What then? They’re going to stare at their portfolio all day and freak out at every little movement. If it actually goes down (and it always eventually goes down), they’re going to think “Crap crap crap, I’m such an idiot! This was a terrible idea!” and then they’ll panic-sell and never touch investing ever again.
Dollar Cost Averaging fixes all of this. By wading gradually into the water and investing periodically, no matter what happens in the market, the investor will always feel like they’re in control. If the markets go down, they’ll think “Oh good. I can pick up more units at a cheaper price. I’m so smart.” And if it goes up, they’ll think “Oh good. I picked up some units before and now I’m making money. I’m so smart.”
See how different that experience is?
So ignore all the studies and ignore all the articles arguing over whether Dollar Cost Averaging is better than Lump Sum.
Always Dollar Cost Average. It’s the only way to invest without freaking out.
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I am currently suffering from this analysis paralysis at the moment.. I have a small initial lump sum ready to invest which is a large portion of my NW (just need to finalise an asset allocation, leaning towards 80/20). This is basically the post I needed to read so I can ‘just do it’. Thank you for that.
Now my question is, is it wise to split this lump sum so I can invest it quarterly over the next years time, monthly, bi-weekly? Does it even matter? What’s your opinion?
As for holding USD, what assets should be held in USD anyways? From what I understand it should be the ETFs with lower fees from the States and tax advantaged ETFs in the RRSP due to dividend withholding tax?
It seems like USD can be used to hedge CAD, although there are costs to convert. It seems wise to have a small percentage of money in USD in my opinion (you have mentioned you have 25%).
Phew that is a lot of questions. Let’s go through them one by one.
1) How finely should I split my purchases?
Once you decide your time-frame for deploying your cash, from a mathematical perspective, it really doesn’t matter how finely you dice your purchases. From a psychological perspective, I’d suggest the more often, the better. Why? Every time you hit “buy”, your brain gets a hit of either adrenaline or fear (in the form of adrenaline). And the more often you experience this adrenaline hit, the quicker you become desensitized to it. And believe me, hitting buy in the stock market crash of 2008 was the most adrenaline-producing thing you could imagine, but even then I kinda got used to it. And when the markets turned positive, I realized the stock market isn’t all that scary. The quicker you can come to that realization, the better. Because that’s when you start making serious money.
As for holding USD, you are correct. We hold about 20% of our assets in USD, and this is because in a market meltdown, assets flow towards the USD since it’s considered a safe haven. Converting however can be expensive, which is why we employed something called Norbert’s Gambit. We will write up an article on this in the near future.
Thank you for the response and the blog! Sorry for the barrage of questions. I am looking forward to the article on Norbert’s Gambit.
Maybe it would be wise to include something on the costs of the conversion typically, as well as with various amounts of cash 1k, 5k, 10k etc. It may vary for various brokers as well.
Yupperinos. That’s what I’m test driving the brokerage companies on right now.
Reminder to write that article on Norbert’s Gambit!
For DCA with diversification, I mostly by vanguard sector etfs, high dividend etf, some value and growth etf as well. The moment salary hits my checking account, I just order assigned amount. Less stressful than making mind every time.
Great article FireCracker, Warren Buffet has recommended to DCA for 10 years if you have a lump sum, what are your thoughts? Thanks 🙂
For a lump sum, I’d say spread it out over 2 years and invest at the beginning of each month. It’s really up to you, but you don’t want to dump it in too fast, and if you go past 2 years, and you may under-perform.
DCA only makes sense when you don’t have a lump sum to invest. If you have a lump sum to invest, invest it, otherwise you’re market timing. Buffett doesn’t do it, which is why he probably didn’t put a lot of thought into it. If you want a good explanation for why DCA isa bad idea for lump sums, here are two short articles by Ric Edelman.
http://www.edelmanfinancial.com/…/q/qa-lump-sum-investing-vs-dollar-cost-averaging
http://www.edelmanfinancial.com/…/q/qa-investing-a-lump-sum-or-dollar-cost-averaging
I have to agree. When I began investing a couple of years back, even with just a few thousand dollars, I invested it all at once (in a mutual fund of course!). Over the next few months I watched it rise and fall every day, constantly questioning my decision to invest and panicking at the slightest movements.
In hindsight it was quite pathetic and funny, as now my (ETF) portfolio is a lot higher yet I don’t care when it has a terrible day, I know come payday I’ll be investing more and getting more for my money. Once you have gained the confidence to invest without worrying about short-term market movements, I’d say lump sum investing isn’t so bad. That being said, if I received $100k tomorrow, I’d likely spread it out over one or two years just to be safe. It really comes down to your comfort level, you want to avoid emotions as much as possible.
Smart. Hopefully, as our readers get more comfortable with investing, they’ll realize (like you did) that it’s really not that hard or scary. DCA will show them the way….
I think I had the benefit of starting young, learning a lot and gaining confidence with a small amount of cash. I can’t imagine entering the world of investing with a few hundred grand and no idea what I’m doing. THAT would be terrifying.
All investing is terrifying. Good on you for figuring this out now.
Also, Vancouver Brit, by moving from Britain to Vancouver you traded fog for fog. Why?!?
We do a mix of both when we have a lump sum to invest (like we do now that we re-mortgaged ourselves, and accessed the equity in our formerly paid off house). I’m a fan of lump sum investing, but my wife likes to DCA. So we take half and lump sum invest on day one, and spread the other half out over a year.
It’s suboptimal, but I suppose that’s kind of the point.
Dear FireCracker,
I’m planning to invest into ETFs, I have a USD. I would start now, and follow 60-40 rule…but now? SnP500 is at all-time-high, and bonds also not performing badly.
So seems to me, if I would invest most of my money into SnP, I can guarantee my portfolio reduction in 1year. 🙁 So starting these kind of portfolios in these days, from zero…maybe not the best…
What is your suggestion? 1) try to invest all in 60-40? 2) try to fragment, and quaterly invest? 3) wait for bigger shocks? 4) instead of 60-40, bond only, or 40-60, with bigger bond? (assuming stock market downturn?)
I have read this article, and I can agree with that…but anyway… 🙂
Thank you ! You are really usefull! 🙂
Hi Linda!
Okay, so not knowing your age or situation, I can’t comment on the appropriateness of your asset allocation, I can only say that 60/40 worked for us.
If you’re a beginner, I usually suggest a more conservative 50/50 split to dip your toe in the water. After you get practice rebalancing in your first market crash, you’ll get more comfortable with investing and then you can decide if you want to up your equity allocation.
And yes, quarterly investing is how we would go about it. If it goes up, great. And if it goes down, you’ll be patting yourself on the back for picking up more units as things decline.
Also, I’m assuming you’re talking about doing this with a relatively small amount (ie a few thousand). If you’re actually talking about a sizeable portfolio (>$100k) you may want to talk to a licensed financial advisor so he can do a proper analysis of your situation. I can refer you to mine if this is the case, he knows what he’s doing.
Hi FireCracker! 🙂
thank you very much for your fast answer.
I’m 34. I have experience on stock market and investment (since 2008) :).
I only want to start this lazy portfolio world, starting with ~30% of my portfolio, and on quaterly basis, I would like to increase, so this percentage would increase constantly (till 60%?) So this lazy part of my portfolio would be that 60-40 stock-bond.
The question and the tricky thing is that we are in a really ATH situation, when SnP at the top…Starting this with a really high level buying (and the percentage of the lower prices in next 1-2 years are really high) would not be so smart.
That’s why I’m hesitating, how can I start this, what would be the smartest thing. 🙂
Anyway, do you still follow the 60-40 or you apply any other static portfolio model? (permanent, bernstein, tomato,… or a more dynamic one?)
Thank you, and I’m really happy to find you! 🙂
So you’re already invested, and you’re considering moving more and more of your portfolio into a passive index? That’s a totally different story. DCA assumes you’re going from cash into equities. Going from equities to equities is a whole other ballgame. What are you invested in currently? (Feel free to shoot me an email if you’re not comfortable talking about this in public)
And yes, we are still 60/40 for now.
Hi Firecracker,
Thank you for sharing your knowledge. Love reading your series and wish I had someone to teach me earlier. I am in a similar situation with Linda in that I am already invested in equities and would like to move to index funds. I am also moving my previous 401k’s into Vanguard indexed IRAs. What do you recommend? Can you also provide me the name of your financial advisor?
My financial advisor’s name is Garth Turner and you can contact him through http://www.greaterfool.ca/contact-garth/
And that’s a great decision to make. I am not at all a fan of actively traded funds. Indexing is the way to go.
Hi FireCracker and Wanderer. Great site! I’ve been following the Investment Workshop and I’m taking steps to transfer mutual funds from three different RRSP accounts in-kind into Questrade, as per your advice. All have MER of at least 2% – and mediocre performance at best. I’m ready to stop paying these extraneous management fees!
I am transferring about $160,000. Approximately $70K may be liquidated with no load/penalty. The remainder ($90K) may be liquidated but I will be have to pay approximately $3K in sales charges (because the $90K are currently invested in DSC mutual funds); they won’t mature until 2022.
Because the $160,000 ($70K + $90K) are currently invested and are not cash, how would you I recommend invest this amount using the DCA method?
Also, if it makes any difference, know that the $90K in DSC mutual funds last year returned +5% overall.
Hi,
Thank you for sharing all of this wonderful content for people who are beginning to learn about the power of investing.
I had a few questions about adjusting asset allocations in a 401K:
A mistake I made was rolling over my 401K from a previous job to my current 401K plan rather than an IRA through Vanguard… I also ended up selecting a target date fund (JTSYX, Net E/R 0.51%) for the rollover. Since reading numerous FI blogs, I felt comfortable enough to change my purchases to VIIIX; however, my current holdings are ~75% JTSYX and ~25% VIIIX. I am considering re-balancing in terms of having an 80/20 allocation of VIIIX (Net E/R 0.02%) and VBTIX (Net E/R 0.04%). Would that make any sense? If I were to adjust the allocations should I approach it in a DCA manner or would I do it as a lump sum? Should price per share of each fund be considered?
Much thanks!
There is no way you’re investing in VIIIX. Because according to Vanguard (https://investor.vanguard.com/mutual-funds/profile/VIIIX) VIIIX require a minimum investment of $100 MILLION dollars. And if you have that much money, just ask the army of lawyers and accountants at your disposal rather than some random blogger!
Thanks for sharing, but please correct me if I’m wrong:
Did anyone “not” notice a weird thing here??
In figure 4 where illustrate dollar average vs lump sum, the dollar average (blue curve) begins at $100K, which is exactly what lump sum is doing. Shouldn’t it begin at $0 (or whatever the small amount investor tries to put in every once a while)? How does blue curve being calculated? Could you provide more details on how you construct this plot?
Thank you.
Hello there. Great article. Thank you for this. I also am wondering the same thing Mark asked back in March. It’s probably a very simple explanation, but I am in a position to begin investing up to 30k USD and am on the fence about how to go about it, lump sum or DCA. This article is helpful as I like pictures and graphs. The DCA vs. lump sum graph that shows the 2 year period starting in 2008 has the DCA starting point at 100k. As Mark asks, shouldn’t this start at a lower amount because we are assuming this 100k is buying into the market incrementally over time? Thanks for any clarification you can provide and happy thanksgiving!
Why do both the graphics start at $100,000 and how much was invested every two months?
Difficult to trust these image
Curious to know if you guys have discovered value averaging (DCA 2.0 as I like to think of it) and if you have any thoughts on it.