Monday, August 26, 1996
Dragging Down Sacred Pillars
by MF DowMan

The Wall Street investment community has a number of sacred pillars propping up its mystical hold over the American investor, many of which The Motley Fool has done its best to demonstrate to the public as facade. They don't bear any real weight at all.

One such pillar, however, that we haven't questioned much in these Foyers of Folly is dollar-cost averaging. The problem with discussing dollar-cost averaging is that it can be used in two very different circumstances, one of which is very Foolish, the other foolish (little "f").

Dollar-cost averaging is simply the practice of investing the same amount of money each month (or quarter) over time to smooth out one's purchase price. When the market's low, the theory tells us, you get more shares for your money, and when the market's high, you get fewer shares. But the average cost is supposed to be better using this method.

Now if an investor is using this approach as a regular savings plan, having a set amount of money taken out of each paycheck in order to invest it, that's terrific. The fastest way to accumulate wealth is to save regularly and to invest well, letting the magic of compounded growth do its bit. But I don't really think of this as dollar-cost averaging at all. This is simply disciplined saving. The goal with a monthly regular investment here isn't to smooth out one's purchase price; it's to get as much money working as quickly as possible by taking a portion of one's salary each month and investing it. What could be more Foolish?

The situation I think needs to be re-examined, rather, is when the investor has a choice. You already have the $50,000 sitting in your bank account (whether from a retirement plan cash-out, an inheritance, a big bet on the Super Bowl, whatever). Do you invest it all at once or dollar-cost average it over the course of six months or a year?

Most investing professionals will tell you to go the dollar-cost averaging route to avoid the risk of a market downturn. But is this really putting the odds in your favor? Well ... no. A number of recent articles have suggested that the market goes up between 70% and 75% of the time. (You can do the math, then, to figure out how much of the time it goes down?)

With those odds, the smartest choice, based on probabilities, is NOT to dollar-cost average your investment, but get it working all at once from the beginning. The odds are seven in ten that by doing so your returns will be higher than if you eased your money into the market gradually, with each installment likely to be at a higher price than the previous one.

Sure, you might be unlucky if you invest all at once and hit that three in ten chance of a downturn, but that's all it is -- luck. Sometimes it's good, sometimes not. You could just as easily hit a downturn the day after you invested your final installment with dollar-cost averaging. The point is that no one knows what's ahead in the short term. All you can do is to put the best odds behind you and invest for the long haul. Time and Foolish investing techniques are still on your side to make up for any bad short-term luck. But for my money, seven out of ten looks a lot better than three out of ten.

Transmitted: 8/26/96