The New York Times Falls for Dollar Cost Averaging

Jeff Somer recently wrote in the New York Times:

Experts say amateur investors tend to make two basic mistakes: they are swayed by emotion, and assume that recent performance will predict the future. Yet it’s not hard to sidestep these pitfalls with help from classic strategies known as asset allocation, portfolio rebalancing and dollar cost averaging.
Basically, these approaches work this way: After assessing your needs and risk tolerance, you set up and maintain a broadly diversified portfolio, adding regular contributions if you can. These practices mitigated investor losses over the last few years, and have an excellent long-term track record. But they are often ignored or discounted.

Oh boy. Dollar cost averaging (DCA) is the myth that will never die. It’s sad to see even the New York Times passing this on as sound advice.
The idea of DCA is that you put a set amount of money in the market each month. If you’re like many investors and have a set amount available to invest each month, that’s fine practical advice.
The problem is when DCA is compared with the option of lump sum investing. If don’t have the option, fine, go with DCA. But if you do have the option, go lump sum all the way. The advantage of dollar-cost averaging was blown to smithereens 30 years ago in this article by George Constantinides.
Somer goes on to write:

Left to their own instincts, most people are “momentum investors,” setting themselves up for failure, said Louis S. Harvey, the president of Dalbar. “When the going gets tough, investors tend to panic, and that happened last year. They sold when the market went down. When it goes up and things get expensive, they tend to buy.”
Sophisticated people often make these mistakes, perhaps because, on an intellectual level, investment decisions are different from those in many other parts of life, said Francis Kinniry, who heads the Investment Strategy Group at Vanguard.

Wrong again. Strange that a person at an index fund is critical of active investing! In fact, momentum investing is one of the very few strategies that have been shown to beat the market consistently. The difficulty with momentum that investors have is they’re afraid to sell when a high momentum stock loses its momentum.
Somer is correct that your emotions aren’t your friends when it comes to investing. Neither, however, is the Wall Street establishment.

Posted by on November 23rd, 2009 at 1:37 pm

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