Dollar Cost Averaging Revisited
Dollar cost averaging (DCA) is a simple and popular formula strategy used by many individual investors as a time-honored way of trying to increase long-run investment returns. As mentioned earlier, the DCA strategy is founded on a simple rule: Invest the same amount of money each time period, regardless of the price. You accumulate wealth gradually over time through a consistent inflow of investment dollars at a steady rate, during good times and bad.
Sticking to the formula means that you avoid the nervous selling during market panics that leaves so many individual investors on the sidelines later during the inevitable upward turns coming out of a down market. The formula also provides a discipline by which you increase your exposure to market risk and return gradually over time, thus avoiding ill-timed, near-peak investments that entice your dollars into a feeding frenzy at the crest of every bull market wave. Dollar cost averaging is an automatic market timing mechanism that eliminates the need for active market timing. According to John Markese, Ph.D., director of research for the American Association of Individual Investors, “Dollar cost averaging gives you time diversification.” This time diversification is different from that seen in Chapter 1. There, we saw that longer investment periods reduced the average annual volatility of the compound annual return— very few long-term investment periods saw a loss. Spreading out your actual purchases ...