A reporter from SmartMoney contacted me a couple of weeks ago to ask me to participate in a little game they were hosting. “All you have to do is guess when the Dow will hit 10,000,” she said. “This is just for fun.”
“I’ll do it,” I replied, “but I want to make it clear that this is just a guess. Nobody really knows.” I told her the Dow Jones Industrial Average would reach 10,000 again on October 15th at 10:22am Eastern. I was wrong — but not by much. It actually reached 10,000 at 1:21pm Eastern on October 14th.
I know this because I’ve been sitting here for the past ten minutes refreshing my browser page, waiting for it to happen. And it just did:
The Dow has hit 10,000! We’re saved! The recession is over!
Well, not really. But sometimes it seems like that’s how the media reports things. I find it hilarious that of the three dozen “investing pros” Smart Money polled, my seat-of-the-pants guess was second closest. (Who won the pool? Financial-planning guru Sheryl Garrett, who guessed 10:00am Eastern on October 14th.) Nobody knows what the stock market will do, and the guess of a humble financial blogger is just as good as that of an investing professional.
My brain hurts
While goofing around, waiting for the index to cross that arbitrary but magical line, I read articles linked from Google Finance. One was this piece from MarketWatch about how traders who favor “technical analysis” don’t care so much about Dow 10,000, but are more interested in when the S&P 500 index will cross 1121, which means it will have regained half of what it lost in the bear market. They believe that when the S&P reaches this point, it’ll have momentum to continue to climb.
The interesting part of the article, though, came in the middle. In the “befuddling rally” section, a “chief investment strategist” says that the market’s continued increase is frustrating to those who are waiting for a “sizable price decline” before re-investing.
Do price declines in the market get any more “sizable” than the one we experienced from September 2008 to March 2009? What were these people doing with their money then?
Are there really people who are waiting to invest in stocks because they want the market to fall 5% or 10%? That seems crazy! By waiting, they continue to miss out on market growth. Have they been waiting since June? Since March? Will they finally put their money back into stocks at the start of the next bear market? And will they then pull the money out again when the market hits bottom?
In another MarketWatch article, a second “chief market strategist” is quoted as saying that the Dow breaking 10,000 could bring back a “whole portion of the population that walked away from Wall Street in the last couple of years because of everything that has happened”.
sigh
I don’t even know what to say. This sort of stuff drives me nuts. I guess it’s another reminder that it pays to ignore financial news. I’ll just keep investing my money at regular intervals, thank you very much. All of this guesswork and market timing seems like a bunch of nonsense.
Folks, stick to your investment plan. Don’t try to time the market. Keep your goal in mind, make contributions to your retirement when you can, diversify, and don’t let the financial media mess with your head. They don’t know any more than you do.
Footnote: The Dow closed above 10,000 today for the first time in more than a year. CNN Money writes: “While 10,000 is not a significant milestone on a technical basis, it’s meaningful on a psychological level, analysts say. It could either usher in more buyers or give investors who think the rally has been too much, too soon a reason to retreat.” I love that. It basically says: Well, maybe more people will invest now, or maybe they won’t. Really? You think? See also: Our recent discussion of Mr. Market’s wild ride.
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JD
I know a man who cashed out shortly before the low of March 9. He is still waiting to find the “perfect” time to get back in. He’s afraid of another correction and he’s afraid he is missing the run up. Truly a lose-lose situation.
When you try to time the market you need to make two perfect decisions–when to get out and when to get back in. One is difficult. Two is nearly impossible. Which is why timing doesn’t usually work.
Better to stay the course as you said. Keep adding to your portfolio when prices are cheap. Then wait for it to come back and reap the rewards.
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@Ross Williams
“On average, you will win a coin flip 50% of the time. If someone offers to give you odds of 101 to 100, you will, on average, come out ahead if you flip the coin enough times. But if you flip the coin once, you don’t get any benefit from the averages – you will either win or you will lose.”
I understand what you’re getting at, I just don’t think this analogy makes sense here. The only way I buy into this argument is if you’re buying AND SELLING on every coin flip with your dollar-cost averaging strategy, which I’m pretty sure is not what you are saying. The thing that tips the argument in favor of lump-sum investment is not that everything averages out to the mean, its that everything DOESN’T average out to the mean, it goes higher (as you got at above with your 101-100 odds, although in my opinion, the odds of the market being higher 25 years from now are much better). By lump-sum investing, you’re not just flipping the coin once, the coin gets flipped every day no matter what, whether you’re totally invested or you’ve only invested partly due to DCA (I’m assuming that in your coin flip analogy, the flip is whether for any given day/week/whatever-time-period, the market will go up or down). The stock market doesn’t just stop moving because you aren’t investing. The point is that if you believe that after ALL of the coin flips are done the end result is going to be higher, than you want to have as much money invested as possible, as soon as possible.
“To be clear, dollar cost averaging is a risk management strategy. Like most things that lower risk, it often lowers average returns.”
I agree with this statement, which if my strategy was short term it might make sense, but in the long term, I believe dollar-cost averaging doesn’t stand up the way everyone assumes it does.
“If you invested all your money at yesterday’s close instead of today’s (the market is down at the moment) you will never recover the difference.”
Unless I’m totally misunderstanding what you’re saying right there, that statement just seems ludicrous. Of course you can recover the difference, unless you had to sell at the close of that one day, but as I said above, my theory doesn’t pertain to such short-term investing. I must not get what you’re saying because if the market goes up more the following day than it did on any given down day, haven’t you recovered the difference? It seems as if you’re talking about timing the market, which we can all agree is a bad idea. Of course if you waited until AFTER a down day to invest it would be better.
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I think you are misunderstanding what I am saying. Say you buy 10 shares of stock for $100 total and the the next day you could buy 12 shares for $100 total. If you invested $50 each day you would end up with 11 shares. If you bought 10 shares, you will never own 11 shares. No matter how high your 10 shares go, you will get 10% less when you sell them. You will never make up that difference.
With a volatile market, the price you pay any particular day could be 1 or 2% higher or lower than the day before or will be the day after. If you buy in a lump sum you are gambling that you hit one of the lows.
And the market is not just volatile on a daily basis. It dropped a lot between January and March and has been on a run since then. If you put a lump sum in the market in January (or in November 2008 for that matter) you would have been able to buy a lot more shares if you had cost averaged that investment over the last year. And the (maybe 20% ?) difference in the number of shares you own will still be there 40 years from now when you cash them in for your retirement.
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@Ross Williams
OK, I get what you’re saying, but my issue is that you’re selectively choosing your frame of reference. What if on the second day you could only get 8 shares for that hundred? Then you only have 9 shares after 2 days, and you lose out to the lump-sum investment which has 10 shares.
The bottom line is that if you believe like I do that the market will go higher in the long term, then by definition the up days will outweigh the bad days. Therefore, getting in as much as possible now is the way to go.
“And the market is not just volatile on a daily basis. It dropped a lot between January and March and has been on a run since then. If you put a lump sum in the market in January (or in November 2008 for that matter) you would have been able to buy a lot more shares if you had cost averaged that investment over the last year. And the maybe 20% difference in the number of shares you own will still be there 40 years from now when you cash them in for your retirement.”
For every period you select where DCA works better, I can find you a period where lump-sum works better. Hind-sight is always 20/20. Instead of trying to find a specific micro-trend where your strategy works, I tend to look at the bigger macro trend. Taking into account that NOBODY can time the market, I’m going to give my money the best probability of getting the best returns. And if the market is going to be higher 25 years from now, then that best probability is putting it into that market ASAP. I fully acknowledge that I don’t know what the market will do tomorrow, but I believe I know what it’ll do over the next 25 year period.
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@ Kevin, #41
“Great advice, Pey. I did that with Nortel stock. I did that with Nortel stock and watched $10,000 plummet to literally pennies. People should structure their investing around buy-and-hold and dollar-cost-averaging. Anything more complex will eventually burn them. Maybe not right away, maybe not for years. But eventually, everyone’s luck runs out. NEVER try and time the market. It’s a good way to squander wealth.”
Kevin, you make a very good point. I was never advocating putting all eggs in one basket; you made the very good point that it is important to diversify in case a business goes under. But, from what you have told me, whether you were dollar cost averaging or using my method of buying at historical lows, you would have lost all your money either way.
Could you please explain how dollar cost averaging would have prevented you from losing your thousands?
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“The bottom line is that if you believe like I do that the market will go higher in the long term, then by definition the up days will outweigh the bad days.”
That is why the single coin flip analogy applies. If you are investing a lump sum all at once, you are only investing on one day, good or bad.
“tend to look at the bigger macro trend”
You are still missing the point. No matter how long the period of time, you have the same problem. The market will go up on average, but it will go up and down a lot in getting there. If you pick one of the peaks to invest your lump sum, you will have many fewer shares to sell than the “average” investor over that same period of time.
It is quite obviously not true that investing ASAP will always bring a better return. On “average it will. But the only way you can take advantage of that “average” is by spreading your money out over time in a series of average investments. Otherwise you are flipping a coin on what market volatility will do to your investment.
If you got a $million inheritance in January 2000 and bought stock in a lump sum, those shares have lost about 20% of their value. If you divided it into 10 equal investments each January, you have a lot more shares of stock. And no matter how long you hold those shares, you will get more for them when you sell.
There are points during that 10 years when if you had gone “all in” you would have more shares. There are also points at which going “all in” would have left you with even fewer shares. The problem with lump sum investing is you don’t know which is which until after the fact.
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“If you got a $million inheritance in January 2000 and bought stock in a lump sum, those shares have lost about 20% of their value. If you divided it into 10 equal investments each January, you have a lot more shares of stock. And no matter how long you hold those shares, you will get more for them when you sell.”
I hate to keep going back to this, but you keep giving me examples. If you want to play the date game, then what if that inheritance was on March 10th, 2009, or March 10th 1989. DCA over those time periods up to today and you would have fewer shares than me and nothing you could do would get those shares back.
“But the only way you can take advantage of that “average” is by spreading your money out over time in a series of average investments. Otherwise you are flipping a coin on what market volatility will do to your investment.”
I think this statement is false. Yes, I could invest my lump-sum on a peak. However, if we’re agreeing on the long-term upward movement of the market, then there will be a higher peak that you will be buying at with your DCA strategy, then another peak higher than that, and so on and on until you’ve bought more of your shares when the price was higher than the original and therefore have fewer shares to show for the same monetary investment, which WILL happen as you take the calculations to infinity (I realize we are not investing for an infinite number of years, but I’m a math nerd, my brain speaks in calculus). Taking the calculations to infinity is the best way to define this equation, but in real terms this would happen much quicker.
I think I just realized one of the disconnects between us. You assume that by me talking a lot about average movements that I’m trying to obtain an average return. I’m not. What I’m trying to obtain is the results of a pattern that is based on averages. I know it sounds like semantics, but let me explain:
If I invest $1 million in the Dow at 10,000 and 15 years from now the Dow is at 11,000, then my return is the END RESULT of that pattern, i.e. the Dow gaining 1,000 points, regardless of whether the day I bought on was a “good” or “bad” day. Your DCA argument however, is completely a victim to the DAILY PATTERN that it took to get to that 11,000. If the pattern goes one way, you lose, if it goes another way, you win, but for me, I always win.
Here’s an example for both sides. If the Dow almost immediately goes to ~12,000 and hangs there for a while before coming back down to 11,000 at the end of the period, you’ll have much fewer shares than me because all of your buying was done at above 10,000 (my buying price). On the flip side, if it goes down to 9,000 and hangs there for a while before jumping to 11,000 near the end, you have more shares than me because most of your buying was done at 9,000.
However, in the 2nd example, you STILL bought some shares (much fewer I know) at above my buying price, whereas in example 1 you did not buy a single share below my buying price. This may seem insignificant, but it comes directly from the fact that over the period, the final price is higher, so at some point the price had to cross my buying price to get to that higher number. In the above period, with DCA, there’s no way for you to buy all your shares at a discount to my price, some will come at a premium, on the other hand there is absolutely a way that you don’t buy any shares below my price.
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I completely agree with you, Will.
I believe dollar cost averaging is great strategy for your 401k, but I’d much prefer to use my ‘extra money’ investing at times when I think the market is undervalued.
It may be risky and I may be ‘burned’ in the future, but then again, I’m willing to take that risk for the opportunity to make much more than a dollar cost averaged portfolio.
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Dow 10,000 is surely psychological, as Warren Buffett has stated “Price is what you pay, Value is what you get”.
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“It may be risky and I may be ‘burned’ in the future, but then again, I’m willing to take that risk for the opportunity to make much more than a dollar cost averaged portfolio.”
Right. If you want to gamble, then timing the market is a better option than a casino.
Will,
Let me do the coin flip analogy one more time. If you flip a coin once there is a 50-50 chance it will turn up heads. If you flip it twice. There is a 25% chance you will lose both times, a 50% chance you will come out even and a 25% chance you will win both times. As the number of coin flips increases, the chances that you will come out losing everything declines and so do the chances that you will win everything. That is all that dollar cost averaging does. It makes it more likely you will get close to an average return rather than one of the extremes.
“If you want to play the date game, then what if that inheritance was on March 10th, 2009, or March 10th 1989.”
To be clear, you are the one playing the date game because you are investing all your money on one date. And yes, as your examples show and as Pey points out, you can make a lot of money that way. As my example shows, you can also lose a lot of money. If you want to gamble, time the market. If you want close to an average return on your investment, dollar cost average.
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“Right. If you want to gamble, then timing the market is a better option than a casino.”
I think we can all agree on one thing: Warren Buffet didn’t make his fortunes dollar cost averaging.
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I understand the coin flip analogy, I just don’t think it applies here. With a series of coin flips you have a closed system where the positive result (heads) and the negative result (tails) are both equal and opposite and the end result moves towards dead even. In the stock market, the positives and negatives are almost NEVER equal, and based on my underlying assumption (overall upward movement) NOT moving towards dead even. It is those 2 factors that differentiate the 2 systems, and in my opinion differentiate them enough to make me take a different strategy. If we were playing the coin flip game, I would absolutely dollar-cost average. But not in the markets.
“To be clear, you are the one playing the date game because you are investing all your money on one date.”
Sorry, by “date game” I meant going back and finding specific dates to “prove” your strategy, not the dates on which you or I plan to invest our money. Also, I’m not timing the market by picking a specific date and investing a lump-sum then. What I’m actually doing is putting the money I plan to invest into the markets as soon as possible to take advantage of my theory. Even though they both result in putting a lump-sum in on a single day, I am not timing the market. I am not using market factors to attempt to determine some arbitrary “best” day to invest a lump sum. I am simply getting as much money into the market as soon as I can to let the market do its thing.
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“Warren Buffet didn’t make his fortunes dollar cost averaging.”
Warren Buffet didn’t make his fortune buying and selling stock.
“What I’m actually doing is putting the money I plan to invest into the markets as soon as possible”
You are choosing to invest at a single time. It doesn’t really matter how you choose that time, whether it is random, based on the moon cycles or when you think the market is at its low point. Any of the three are likely to yield basically the same result.
“With a series of coin flips you have a closed system where the positive result (heads) and the negative result (tails) are both equal”
True. If you accept the notion that the market is always more likely to go up than down, then the odds of winning are better than the odds of losing. But even if the coin is loaded so it turns up heads 60 per cent of the time, it will still turn up tails every time 40% of the time with one flip and only 16% with two flips and 6.4% with three flips. And your chances of being close to the 60-40 average will increase with each additional flip.
Investing in stock is not like a savings account. It doesn’t really matter when you buy stock or how long you hold it. It is the price when you buy and the price when you sell. (Ignoring dividends, which adds to the advantage of buying more shares, but also adds to the advantage of owning them over a longer period of time).
I think it is important to remember you are talking about one investment. If you are investing once a year for 30 years, you are in effect dollar cost averaging. Chances are that the monthly fluctuations in the stock market will even out over those 30 investments. You will hit some peaks and some valleys. But if you investing ten times as much in one cycle, you are gambling on hitting the right point in the short term fluctuations in the market. And that is a bad idea if you are investing and not gambling.
If you got that $million inheritance last September you have a lot less stock than if you got it today. And if you got it in January, you have more stock than if you got it now, if you got it in March you have a lot more stock than January or now, and if you got the money now you will own the least stock. No one knows how much you will own if you get it next January. The price you get when you sell will be the same in all cases. The number of shares you own when you sell could vary up to 60% based on the random event of when you received the money. Putting it all in the market on any one of those dates – based on when you receive it – is just gambling that it won’t be the wrong time.
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“Investing in stock is not like a savings account. It doesn’t really matter when you buy stock or how long you hold it. It is the price when you buy and the price when you sell.”
Agreed, but the underlying assumption of upward movement as the period length increases actually ties these 2 factors together. In my opinion the longer you hold a stock IS connected to the price at which you sell it. That’s part of what my theory is based on.
“(Ignoring dividends, which adds to the advantage of buying more shares, but also adds to the advantage of owning them over a longer period of time)”
Haha, I was wondering how long it would take you to get to that. My overall investment strategy is what most would call an income strategy. As you pointed out that gives more importance to buying more shares and holding them longer. About 75% of my holdings are companies with good dividends and histories of consistent dividend increases. To further muddle things up, all of those are set to immediately re-invest those dividends, so I guess that gives me some aspects of the DCA strategy (invest small amounts on a quarterly basis). So, obviously my strategy becomes more valuable having revealed that, but I still think it stands on it’s own merit.
Anyway, I’d like to thank you for having this back-and-forth with me. If you couldn’t tell, I love these kinds of debates, but I highly doubt either of us is going to convince each other to “switch teams”. In the words of Ron Burgundy, let’s “agree to disagree.”
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OK, I told myself I wouldn’t comment anymore on this subject because we’ve hi-jacked this thread long enough, but I found something very interesting.
I started looking around different financial sites to see if I was just insane, or if other people agreed with my viewpoint. There were tons of articles on both sides (though admittedly FAR MORE on the DCA side), but I found one that was fairly recent (within the last couple years) and did a very thorough analysis of DCA vs. lump-sum investing.
http://knol.google.com/k/michael-edesess/the-myth-of-dollar-cost-averaging/3twuo3uafq5n8/7#
If you follow that link, the numbers seem to split our arguments right down the middle. The average return for lump-sum was higher over 1, 3 and 5-year periods (my argument), but the deviation was also higher which tells us that DCA is a more effective risk management investment (your argument).
Something for me to chew on over the weekend, I guess.
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To further illustrate the utter useless nature of the “10,000″ mark, consider that since the Dow hit 10,000 10 years ago, by using the rule of 72 and a conservative assumption of 7.2% annual returns which is less than the long term norm, the Dow technically should have doubled by now (72/7.2=10). So, if anyone wants to get excited about even reaching the old inflation-adjusted Dow number, it should be at 20,000 not 10,000. When I say inflation, I’m referring to expected-market return inflation, not CPI or something of the sort.
Either way, great article; everyone can and should go back to approaching equities in the same manner in which they were a month ago… Market Allocation = (f) Risk Tokerance, Time Horizon. It is not a function of markettiming (IMHO).
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Will -
Anyone who tells you dollar cost averaging will “beat the market” doesn’t know what they are talking about and neither does anyone who debunks that red herring. The point is to reduce the risk that the market will beat you.
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Ross –
I couldn’t agree more. Despite what you might think from my arguments, I actually think dollar cost averaging is a good market strategy. I just feel like a lot of people take it as fact that dollar cost averaging is the best strategy without even thinking about it. Just trying to open people’s minds up a little, that’s all.
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@Pey (#55):
“Could you please explain how dollar cost averaging would have prevented you from losing your thousands?”
Certainly. I was sitting on $10,000 cash. Nortel plummetted to a new 52-week low. You said: “If the stock is close to its 52 week low, it’s a good time to buy.” So I bought. Rather than trickling it in little by little and dollar-cost-averaging it, I did what you advise, and plunked the whole $10,000 at once, buying at well below its 52-week low.
If I had instead dollar-cost-averaged, then I would’ve spread the purchase out over a year or more, and having seen the entire market implode, probably would have cut my losses and stopped buying Nortel shares well before I had invested the entire $10,000.
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Fair enough and that’s a valid point, but you must admit, had the market soared back closer to its 52 week high and beyond, you would have made a considerable amount of money. There are two sides to each story and, had you chosen the right stock, you would be very happy with your investment choice.
As other individuals have debated and finally agreed on above, dollar cost averaging is great for mitigating risk, which obviously would have happened in your scenario. It is not, however, an easy way to ‘beat’ the market and make more money.
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