Debunking the Myth of Dollar Cost Averaging

This usually comes up because people procrastinate investing and end up with a large amount of money sitting idle. They have anxiety about how to put it into the markets.

Saving with each paycheck isn’t dollar cost averaging. It’s lump sum. DCA would be something like putting 1/4 of your total savings every week.

Anyway, in my experience this situation comes up a lot due to the above

I don't think Sharpe is the right metric here and it has the same flaw as the article. Neither the article nor the sharpe ratio would take into account the fact that in his test much of the capital would remain uninvested for the begining of the dollar cost averaging strategy so it would seem to underperform literally because far less capital would be put to work for the beginning of the test period.

The use case for lump sum and dollar cost averaging (or "Systematic investment" that he mentions in the article, which sounds very much like what I have always called DCA but whatever) are different. Most people don't have a chunk of cash to invest, most people have some small amount of excess cash to invest each month or whatever. So in that world are you better off investing each month, or saving up until you have a lump sum? Almost certainly investing[1] each month.

For that reason, most people in the investment world would use some variant on internal rate of return here, which you could do a risk-adjusted variant of if you wanted to. I expect if you used either of those metrics you would find that DCA pays a small amount of excess return in cases when you would luck out and invest big after a decline in the lump sum case. In return for this, DCA has far lower variance, and far less likelihood of "effective ruin"[2].

[1] Technically if your savings amount each month is very small the transaction costs will eat up your capital if you trade too often so you should save until you have chunkier amounts in that case to mitigate this.

[2] Strictly if you're just investing long in cash equities (not derivs) risk of ruin is practically zero, but for a real person you can be very significantly harmed if say you bought equities at some high water mark, there is a big sell-off, the market basically goes sideways (declines in real terms after inflation) for a long period of time and you have to retire (so you have no earning power) and have to sell gradually at a loss to sustain your standard of living in retirement. This is effectively the position a lot of Japanese investors found themselves in after the big slump there.

Dollar Cost Averaging a lump sum might reduce your risk while you're averaging in, but why weren't you happy with the risk/return profile in the first place? And are you happy with increasingly higher risk/return as you commit more of your lump sum? Isn't it better to pick a portfolio with a risk profile you're happy with in the first place, then commit your entire lump sum?

> If you make a salary from your job, dollar cost averaging makes more sense than saving up your salary and then lump sum investing it at some point in time.

Pedantically, many believe that this is not actually DCA.

DCA is a strategy that is a counterpoint to lump sum investing. From that perspective, the common factor required by both strategies is that you actually have a lump sum to invest.

Investing every month as you earn money, assuming you never had enough to do a lump sum isn’t considered DCA from this perspective because there was no alternative to lump sum invest.

I do adhere to this thinking, and I think it would be useful to have a term for each of these three options. Unfortunately nobody’s proposed one that’s stuck for what you’re describing, so an endless debate rages on financial subreddits whenever this comes up.

I only bring this up because whenever people talk about DCA, there is an implicit assumption that they’re discussing from the perspective of their definition of the term. The article is—I assume—using the definition I described. Because yes, saving up your money to invest in one go at the end is categorically the worst option, and silly enough a strategy that it doesn’t often warrant mention or discussion.

This is why in the post I differentiate between dollar cost averaging and systematic investment. Investing a part of your salary every month is basically the same as lump sum. I don't defend in any moment to save money during the year and invest it after some months. Actually, my advice is to invest the most you can as soon as you can. And in many cases this means to invest a fixed amount of money every month.