Dollar Cost Averaging is a Waste of Time
Dollar cost averaging (DCA) is a strategy of investing for which you put a fixed amount of money into a stock or fund at regular intervals over a period of time such as a year. For example, instead of investing one lump sum of £12,000 you invest £1,000 a month for a year.
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Just to be clear dollar cost averaging is completely different to periodic investing where you're investing a part of your paycheck each month. Dollar cost averaging is a choice you will make if you come into a large sum of money (ie, inheritance) or if you are investing for the first time and have a lot of savings to utilise.
The aim of DCA is to ride out fluctuations in the market. This is because if you were to invest a lump sum into the market and then it subsequently falls the over the following month by 10% you could have prevented such a hit to your portfolio by dollar cost averaging.
However, there is one big flaw when it comes to dollar cost averaging. The aim of any investor should be to maximise their chances of obtaining the greatest possible returns on their investment. By dollar cost averaging you are actually reducing the chances of obtaining the greatest possible returns on your investment. The quote below sums up why.
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"People do dollar cost averaging because they have regret of making one big mistake. But the fact of the matter is that, mathematically, the market rises more of the time than it falls. It falls, but it rises more of the time than it falls."
- Kenneth Fisher
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This is also the reason why you should not bother trying to time the market. Time in the market is always the best route to go.
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What does the Data say exactly?
Jeremy Schneider at the Personal Finance Club performed a really good piece of analysis based off of 150 years of data from the US stock market. What he found was that more times than not lump sum investing was superior to DCA about 71% of the time. You can check out his post on this by clicking here.
What should you do?
When all is said and done you need to do what is most comfortable for you and what will allow you to sleep best at night. The main thing you need to understand if you decide to DCA is that you are not reducing risk, rather you are trading one risk (the market drops after you buy) with another (the market continues to rise while you DCA meaning you will pay more for your shares).
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The data very much supports lump sum investing over DCA. From a mathematical perspective the investing path you should take is clear. From a psychological perspective it can be a much harder decision due to loss aversion. This is where there is the tendency to prefer avoiding losses to acquiring equivalent gains.
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To sum up it is still much better to DCA and own a piece of the stock market than to not be in it at all, if that's what makes you comfortable with investing. If I personally were to run into a lump sum of money, I would be chucking it straight into the stock market.
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