Clients often ask us if we dollar-cost average. Dollar-cost averaging is the time honored principle of investing a set amount of money into a designated portfolio over regularly scheduled intervals until you have invested your total available sum, presumably to lower your cost basis. For nervous or 1st time investors, it is a way of stepping into the market and possibly reducing buyer’s remorse. It may give you peace of mind, but does it aid or hinder performance?
This very topic was highlighted in a Vanguard white paper last year, titled “Dollar-cost Averaging Just Means Taking Risk Later.” Vanguard looked at two sums— a $1 million windfall inheritance and a $20 million cash gift to a charitable foundation. They analyzed 1,021 rolling ten year periods from 1926 to 2011 for three standard portfolios: 100% stock, 60% stock/40% bonds, and 100% bonds, in three major markets: the US, the UK, and Australia. They looked at the returns for the sum invested all at once as opposed to the returns of the sum invested over periods ranging from six months to three years.
So what was the result? On average, Vanguard determined that lump sum investing outperformed dollar-cost averaging about two-thirds of the time over all markets, all portfolios, and all dollar-cost averaging periods in the case study. When dollar-cost averaging was extended to a 3 year investment period, lump sum investing beat dollar-cost averaging about 90% of the time. So the longer one took to invest, the lower the total return.
This result does not surprise us. Returns of stock and bonds consistently outperformed cash in almost all of the rolling 10 year periods in the study. This also agrees with our fundamental belief that the markets, over the long term, have a tendency to rise. It is not our policy to dollar-cost average and this reputable study supports our position.