Thursday, April 10, 1997
Dollar-Cost Averaging
Part 2
or
A passionately Dull Subject?
by
GW Runkle
Recently, I wrote a Fribble on dollar-cost averaging. I figured it would elicit one big yawn, but I was curious whether dollar-cost averaging gave a better annualized return than investing in one lump sum. I never expected the amount of e-mail I received. Typically, one of my Fribbles might get me one or two e-mails. I consider four or five to be a lot. The first Fribble I wrote on Commodore set a record of fourteen e-mails. This Fribble on dollar cost averaging brought me twenty eight e-mails. I couldn't believe it. Only one flame in the bunch, which surprised me too; with that kind of response you'd expect more. Of course, how do you flame dollar-cost averaging? It's not something to get passionate over.
The letters came from as far away as Australia and England. Apparently, they don't have Dividend Reinvestment Programs (DRiPs) in those countries. For those of you in far-off lands, DRiPs are company-sponsored stock purchase plans. They let you invest small amounts of money in the company's stock without paying commissions. Many point out that DRiP investors get higher annualized returns on their money because of dollar-cost averaging. I wanted to check this in my first Fribble.
The writers pointed out a couple of things. First, even if the annualized return from dollar-cost averaging is less than lump-sum investing, it is still better to invest your money in the market as it becomes available. Saving $100 a month in a money-market account until you get $3,600 is not going to get you the same return as if you invested it in the market. I agree, and I just corrected that omission.
The next criticism was that I didn't count the interest on the money you held back of the $3,600 you dollar-cost averaged. That is a completely different annualized return calculation. I assumed in dollar-cost averaging that you didn't have that lump sum in the beginning, and the $100 you invested was done as it was available. If you had $3,600 in the beginning, I have to calculate a return on that whole amount, not $100 thrown in at a time over the period. I did that, calculated interest on money held back, and annualized the return. The result is show below.
Other notes pointed out some more complex things to consider, such as dividends reinvested, time value of the money, and other strategies. I'd like to cover them all, but sadly space is limited. There is so many ways to do this calculation, and I've tried to keep this simple so we can compare results easily. Also, many readers correctly pointed out that my time span was too short, and in an upwardly moving market. Over a ten-year period, the results are noticeably different. I redid the calculations, and making it a bit more painful, Dow-Jones and Company redid the Dow on me. So, this takes into account the new Dow 30. Also, I used more recent data, and notice the numbers narrow a bit even in a three-year period towards dollar-cost averaging as the market has sunk. Here are my results:
Three Years (New Dow):
Annualized Returns Of The Dow:
All At Once: 26.70%
Dollar-Cost Avg.: 25.20%
-1.51%
Total Investment Of The Dow:
Interest
All At Once: $7,322.82 N/A Total Return
Dollar-Cost Avg.: $5,498.20 262.55 $5,760.75 16.97%
$1,824.62
If you had $3,600 in a lump sum and dollar-cost averaged it $100 a month, you would have made $262.55 in interest at 5% annual interest. Your total at the end of three years would be $5,760.75. Your annualized three-year return would be 16.97%. Obviously, if you have the money, put it in the market
Ten Years:
Annualized Returns Of The Dow:
All At Once: 13.90%
Dollar-Cost Avg.: 18.64%
4.74%
Total Investment Of The Dow:
Interest
All At Once: $44,086.32 N/A Total Return
Dollar-Cost Avg.: $30,991.15 2,975.05 $33,966.20 10.97%
$13,095.17
If you dollar-cost averaged that $12,000 from a lump sum at $100 a month, your interest would be $2,975.05. That would bring your total to $33,966.20 at the end of ten years. The annualized ten year return would be 10.97%
Notice my numbers are little different this time with the new and improved DJIA. A couple of things are clear:
1. Dollar-cost averaging gives higher annualized returns when the period includes down times for the market.
2. It is better to invest all of your funds at once; dollar-cost averaging doesn't increase your total return. If you have a lot of money to invest and dollar cost average it, the only thing it increases is your broker's commissions.
3. Investing your money as it becomes available will give you much better returns than a money market or savings account.
Do some companies give better results for dollar-cost averaging than others? Yes, definitely. I'm out of space here, so I'll cover that in Fribble III on this subject. I'll venture my own opinion of why some companies are better than others to dollar-cost average.
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