Dollar Cost Averaging (DCA): : In the Gibberish section of the last issue you described a way to evaluate this investing method. Have you done so, and what are the results? I did a similar analysis, but it is different from what I described in the last issue. Then, I talked about comparing returns from lump-sum and DCA over long periods, but that has the problem of the relative performance near the beginning having a much greater influence than what happens near the end. That is because the early effects get compounded over a long time. Instead, I decided the average of one-year comparisons over a large number of years would provide a more meaningful evaluation.
I used the total return of the S&P 500 index, which can be achieved fairly closely by the Vanguard Index 500 fund. I was able to obtain the monthly total returns starting in 1975. I compared investing $2,000, the old IRA contribution limit, at the end of January with investing $500 at the end January, April, July, and October. The money being held for later investment was credited with interest at 0.25% under the prevailing 90-day T-Bill rate, which is a reasonable estimate of money market interest.
What I found, which probably is not surprising, is that in years when the market went up, it was better to use the full $2,000 to buy stocks at the end of January, and in down years, it was better to dollar cost average as described earlier. Because the market tends to rise over time, there are more up years than down years, so lump-sum investing is advantageous as a general rule. Over the 28 year period 1975-2002, the average yearly advantage was 1.3%. The year in which the lump-sum had the largest advantage was 1995, the beginning of the incredible five-year bull market, when it was 10.2%. On the other hand, the last two years have been severe bear years, and DCA would have had a 14% advantage in each of 2001 and 2002.
Interestingly, there were three years (1982, 1984, 1994) when the S&P was up but DCA had the advantage, between 3% and 4% in each case. There was only one year, 2000, when the market was down and DCA did not outperform the lump-sum purchase. The difference then was only 0.6%. My conclusion is that DCA has merit, but since there have been two up years for each down year since 1921 and an even higher ratio more recently, so making a single purchase early in the year is a better approach.