Subscribe By RSS
Dollar Cost Averaging Myths
By Andy Singh on January 11, 2009 | More Posts By Andy Singh | Author's Website
Dollar cost averaging (DCA) seems to be a hot topic of late with many experts saying to continue buying shares, even as they keep falling in price. For those of you who may not understand DCA, it basically means that you continue to buy more shares in companies that you already own as they fall away in price in order to achieve a lower average purchase price. Now I don’t know about you, but I struggle to understand why anyone would want to buy shares in an asset that is falling. Particularly if they can afford to earn more money in other, more stable investments such as corporate or municipal bonds.
If you had dollar cost averaged into well known and widely held companies like General Electric (NYSE:GE), Citibank (NYSE:C) or Microsoft (NASDAQ:MSFT) over the past 6 months, thinking they had bottomed earlier in the year, you would most certainly be questioning whether this was wise given that shares in these companies continued to fall throughout the year. Similarly, those who employed the dollar cost averaging strategy for many financial or technology companies or ETFs thinking they had also bottomed mid-year would still be regretting their decision as they could have made (or avoided losing) far more money during this time.
In my opinion, and owing to current market conditions, dollar cost averaging or buying shares as they fall away because they seem “cheap”, is not smart investing for the simple reason that most investors do not know where the bottom is and to buy without knowing is speculating. I have evened questioned the current benefits of dollar cost averaging in 401K/retirement accounts (per this post) for the same reason as above, we don’t know when the market will bottom and it seems like stocks still have a long way to fall.
So why not wait till things stabilize and get a much larger amount of stock at a lower price, rather than smaller amounts at higher prices. You may not pick the exact market bottom, but you will definitely be better off than buying a stock that continues to fall. Only when the market stabilizes and resumes normal behavior, will dollar cost averaging become a “smarter” investing move.
Subscribe by RSS 
Subscribe by Email
Email This Post To A Friend
Agree - Dollar Cost Averaging only works in a Bull market!!
–joe
Dollar cost averaging is not aimed at getting a better return. It’s objective is to lower risk. This is particularly true in an account which is being invested in on a regular basis, like a 401(k).
SnoopyJC: Dollar cost averaging is at its worst in a bull market.
Let me give a 401(k) example:
Let’s say the 401(k) asset allocation plan calls for 40% stock, 20% real estate, 20% bonds and 20% fixed income (sometimes called stable value) fund.
If the participant had worried in 2006 or 2007 that stocks might be more of a risk than he wanted to take, he could have moved half (or even all, as some of my clients did) into the other three asset classes. Then he could make his contributions only to the stock fund until the desired long-term 40% was again established. This would be dollar cost averaging into stocks over a time period when he did not expect time any significant rise and feared a pullback.
If , at some time in the future he fears bonds may be headed for a hard stretch, he could follow the same startegy with bonds.
You do not want to be dollar cost averaging into an asset class when it is going up. Not getting as much money as you can as soon as you can costs you reduced returns.
Dollar cost averaging is a poorly understood strategy and misapplied, even by professionals.