Investing

Dollar Cost Averaging and the Great Depression

I have definitely been thinking about dollar cost averaging as an investment strategy a bit these days. My last post about Dollar Cost Averaging In A Declining Market and the discussion in the comments has really helped me get my thoughts together and crystallize just exactly what I was thinking and trying to communicate. Add to that a post that I found over at All Financial Matters (via Get Rich Slowly) and I think I have come up with a much better way to demonstrate what I was trying to communicate in my previous post.

As a reminder, I think that dollar cost averaging in a declining market is not a good strategy (long term or short term) – especially when one dollar cost averages into mutual or index funds. I still hold this position and here is some more information that has helped me stay here.

JLP wrote a post titled Dollar-Cost Average Your Way Through The Depression in which he compared the returns generated from lump sum investing and DCA. Here are his assumptions:

A lump sum investment of $1,840 on the last day of September, 1929 and $10 per month ($1,840 over 184 months) invested on the last day of each month from September, 1929 through January, 1945.

With these assumptions, DCA outperforms lump sum investing handily as this graph that JLP produced deftly demonstrates:

Lump Sum vs. Dollar-Cost Averaging 1929 - 1944

A Better Investing Strategy?

It is incontrovertible that dollar cost averaging absolutely destroys lump sum investing given these criteria, but what happens when we add three more scenarios to the mix? In addition to JLP’s two scenarios I want to add three of my own to the mix: Wait 12 Months, Wait 18 Months, and Wait 24 Months. The assumptions for each of these is that the investor dollar cost averages into the market up until they realize the crash is for real – let’s say 6 months after the crash in October 1929. So after their last investment in March 1930, they hold on to their money and wait to invest in the market until they see signs of some recovery. One person waits 12 months and then invests the $120 that they saved, the next person waits 18 months and invests the $180 that they saved, and the next person waits 24 months and then invests the $240 that they saved. Here is some of the data that I found:

Important note: I was unable to determine how to calculate dividend payments on this “index” fund based upon the prices of the DOW Jones Industrial Average so such payments have been completely left out.  All numbers below represent the market value of “shares” only. This will help explain to those careful chart readers the differences between my graphs and the one produced by JLP. If you happen to know how to include dividends in this analysis please let me know.

Also, I assume that all this occurs in the world of zero cost trades, zero expense ratios, and zero taxes. Wouldn’t that be a great world!

Waiting 12 Months

If a person stopped their dollar cost averaging strategy 6 months into the great depression and held off investing for 12 months they would have generated returns that were essentially equal to those of the DCA strategy, minus the difference in one year’s worth of the additional dividends from the DCA strategy. I assume this difference between the DCA strategy and my modified DCA strategy is negligible, so I think that it would be fair to say that the returns are essentially equal.

Dollar Cost Averaging Strategy Returns: $2369.29
Dollar Cost Averaging Strategy Returns with 12 month pause: $2372.37
Difference: 0.13%

Dollar Cost Averaging With 12 Month Wait

Waiting 18 Months

Waiting 18 months would have made this theoretical investor very happy. Because he waited to invest his money, he was better poised to take advantage of the eventual rise in the DOW as the country slowly dragged itself out of the Great Depression.

Dollar Cost Averaging Strategy Returns: $2369.29
Dollar Cost Averaging Strategy Returns with 18 month pause: $2520.95
Difference: 6.40%

Dollar Cost Averaging With 18 Month Wait

Waiting 24 Months

This is by far the best of the three, but when you look at the graph you will definitely see why – the 24 months lines up with the very bottom of the stock market during the Great Depression. This was a coincidence and is very unlikely in real life, but interesting for our example nonetheless.

Dollar Cost Averaging Strategy Returns: $2369.29
Dollar Cost Averaging Strategy Returns with 24 month pause: $2854.95
Difference: 20.50%

Dollar Cost Averaging With 24 Month Wait

To Dollar Cost Average Or Not To Dollar Cost Average In A Declining Market

Ultimately, the choice of what an individual does with his or her investments is entirely up to them. I am not a financial adviser, stock broker, or even the slightest bit experienced with the stock market. So just because I put up some numbers and graphs on a website does not mean that I should be listened too. In fact, there are probably very many people who think I don’t know what I am talking about when it comes to dollar cost averaging.

I think my choice is clear, I would hold off on a dollar-cost averaging strategy until I felt like I had signals from the market that things were okay now. Since I am not a very serious investor (read no money to invest) I have not done due diligence to see if the market is at bottom or is going to drop further. I would that my hunch is that it will go down farther – but then again, what do I know.

This does highlight something very important about investing in general: if you are going to invest your money make sure that you are educated about what you are doing and have done some of your own analysis. This goes for a Dollar Cost Averaging investing strategy or a stick-it-under-the-mattress strategy.

1 Comment