Dollar cost averaging as a so-called investment strategy has been around for a long time. When the markets started showing signs of recovery this summer, many pundits were suggesting getting back into equities a little bit at a time, i.e. dollar cost averaging. As a retirement investor, does this really make sense?
Why do some people advocate or like dollar cost averaging? I think it’s mostly fear. This is the logical way we should be thinking about retirement investing in the stock market.
1. Do we have money to invest for retirement?
2. Do want to spend our retirement money on something that will increase in value over the long run of our retirement horizon?
3. Are we are prepared to take some risk with our retirement money?
4. Do we believe that the stock market (or certain index funds) will increase in value over the long run of our retirement horizon?
If the answer to each question 1-4 is “yes”, we should take the retirement money we can risk and invest it. All of it. Now. If we really believe in our assessment of risk tolerance and in the future of the market, it makes no logical sense to dribble the money back in. Put it all in and wait for the market to do its thing. If the market is going up as you expect, catch the wave now and capture all of the returns.
The dollar cost averaging advocates might respond this way: “What if the market goes down after I go all in? I’m afraid of that happening. That would upset me. Therefore, I want to put my retirement money in the market in pieces, over time. That way I increase the odds that at least some of the money I put in will show a positive return. I would feel better about that.”
If that’s your thought process, then you really don’t believe the market will go up over the long run. And if you don’t really believe the market will go up over the course of your retirement horizon, why would you want to invest any of your retirement money in that market?
Dollar cost averaging is really an expression of our illogical investing fears and needs. We feel worse about losing money – of any amount – than we do about missing out on market gains, even gains that we predict will be realized. Our response is to spread our investments out over time, so that we might have at least some purchases that go up in value, even if our overall investing return is negative. (To learn more about the behavioral aspects of dollar cost averaging, watch this video.)
The bottom line is this: Most financial experts will tell you that dollar cost averaging a lump sum of money is a sub-optimal investing strategy. To explore that theory yourself, try this DCA vs. lump-sum investing comparison calculator. I think you will find that DCA loses to lump sum investing two out of three times.
Before we invest, we should do our homework and due diligence. If we find a market that we reasonably believe will provide