Research & Insights
Does Dollar Cost Averaging Make Sense For Investors? DCA's Benefits and Drawbacks Examined
Abstract:
In the wake of increased volatility and two equity market crashes over the last decade, a growing number of investors have become wary of putting large blocks of cash to work in the market all at once. Instead, they invest smaller amounts of cash at regular intervals over an extended period of time. This process is called dollar cost averaging (DCA), a strategy often recommended by investment advisors for risk-averse clients. But does this strategy have any investment merit or is it done primarily to allay the fears of investors?
In addition to comparing the historical performance of DCA with a regular lump-sum investing strategy, this paper also looks at variations of the basic DCA strategy to see if they entail any added benefit. The variations of regular DCA strategies analyzed have been termed ‘value averaging’ (value DCA) and ‘momentum averaging’ (momentum DCA). Both strategies involve adjusting the amount of money invested on a monthly basis, up or down, relative to regular DCA, based on the previous month’s return. In the case of value DCA, more is invested if the market has gone down in a pre-specified trailing time period and less is invested when the market has previously gone up. In the case of momentum DCA, less is invested if the market has gone down in a pre-specified trailing time period and more is invested when the market has previously gone up. In addition to determining the relative merits of these strategies, the paper also analyzes their returns during bull and bear markets.