Monday, August 18, 2014

Dollar-cost averaging doesn't work

Bernstein Global Research recently conducted its own study of the subject, and was able to quantify some of the cost of investing gradually. Using the Standard & Poor’s 500-stock index and its predecessors, Bernstein examined the rolling one-year returns of the stock market through 12-month periods from the beginning of 1926 to the end of 2013 — a total of more than 1,000 such periods. It compared lump-sum investments made at the beginning of each period with stock purchases made through “dollar-cost averaging” — regular monthly investments in the S.&P. 500 for 12 months. Money on the sidelines stayed in three-month Treasury bills.

The firm found that the average one-year return was 12.2 percent for immediate investments into the stock index, 8.1 percent for the dollar-cost-averaging portfolios and 3.6 percent for the cash holdings. The penalty for investing gradually, in other words, was 4.1 percentage points. On the other hand, that gradual approach was 4.5 points better than just holding cash. ...

Bad timing happens by accident, though. If you had moved money into the stock market right before a major market peak, you would have been staring at big paper losses immediately.

How bad would those numbers have looked? For a concrete answer, I asked Mr. Masters to sift through his data and find the worst cases among the 12-month periods his firm analyzed.

It turns out that if you had held onto your stocks long enough, you would have come out whole — and much faster than I had expected.

For example, the worst 12-month period since 1926 began on July 1, 1931, during the Depression: The stock index lost 67.6 percent, including dividends, in those 12 months. Yet it would have taken only 39 months — 3.25 years — to erase all your losses, assuming that you had stayed in the market.

In recent decades, Bernstein found, the worst 12-month period began on March 1, 2008, when the market’s return was minus 43.3 percent. Many people bailed out of stocks then and never went back. But if you had stayed fully invested in the market, you would have recovered all of your losses within 22 months — and would be sitting on enormous gains today.