Appendix B. Dollar Cost Averaging

Investors frequently face this kind of issue: "I just received a large lump sum of money. Should I invest it all at once, or spread the investment out over time?" A similar problem arises when an investor has sold during a bear market. The question then is: How do you reenter the market?

Rather than investing assets in a lump sum, many investors use dollar cost averaging (DCA), a timing strategy that periodically invests a fixed amount of money in a particular investment or portfolio over a given time interval. The idea is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time. Such is the theory. But is there any real advantage to using DCA as an investment strategy?

From an academic perspective, answering the question of when to invest is simple and has been known for a long time. The June 1979 issue of the Journal of Financial and Quantitative Analysis published an article by University of Chicago professor George Constantinides titled, "A Note on the SubOptimality of Dollar Cost Averaging as an Investment Policy." Constantinides showed DCA to be an inferior strategy to lump sum investing. In 1992, John Knight and Lewis Mandell published "Nobody Gains From Dollar Cost Averaging: Analytical, Numerical, and Empirical Results," in the Financial Services Review (Vol. 2, Issue 1). Knight and Mandell compared DCA to a buy and hold strategy, then analyzed the strategies ...

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