Dollar Cost Averaging & Market Timing — Part 3
In Part 1 we looked at at the historical returns of dollar cost averaging.
In Part 2 we compared dollar cost averaging with lump sum investing.
In this final part, we will look at the effect of market timing on both dollar cost averaging and lump sum investing. We’ll look at investment starting points during the 10 year low points, 10 year high points, and 10 year midway points.
Our goal is to try to see if it’s worth trying to time the market? Although many would say any attempt is futile at best.
Investing at Lows
Since 1920 there’s been ten points in time that were decade lows. Below are the results if you started Dollar Cost Averaging starting then.
The average 15 year return was 9% IRR.
And what if you did a lump sum investment at the lows?
Results are similar — 9% IRR.
Investing at Midway points
For dollar cost averaging:
And Lump sum:
Again fairly similar results, with lump sum having a slight edge with 10% vs 9% average 15 year IRR.
Investing at High points
For dollar cost averaging:
Lump sum:
Here we see that dollar cost averaging has a slight advantage of 10% vs 8% average 15 year IRRs.
Summary
So what do the three studies suggest?
- Dollar cost averaging has been a very effective investment strategy.
- Stick with a long term view. Five year negative returns can become quite favorable, with perhaps the exception of the 1920s.
- Deciding between a lump sum investment and dollar cost averaging? History shows that there isn’t much difference between dollar cost strategy and lump sum investing. But human psychology may differ. How will you react to a 30% drop if you’ve invested all your capital? For those, you may wish to go with a dollar cost averaging strategy so it seems like you’re actually doing something vs sitting and waiting it out.
