The most important argument in favor of dollar cost averaging — the only one that matters, in my opinion — is that it reinforces scheduled saving. And since most people get paid on a regular schedule, that makes it convenient too.
Of course, most arguments for and against DCA devolve into specifics around things like strategies or allocations. The specifics typically come with examples that make two questionable assumptions.
The first involves assumptions based on past performance, as it relates to the future. Unfortunately, the future isn’t guaranteed to look anything like the past.
The second is that we’re all rational actors.
Conveniently, Ben Graham tackled this in a paper devoted to new (at the time i.e. 1962) saving plans dedicated to buying stock (pensions plans, CREF, variable annuities, and DCA via mutual fund companies):
The computations made of theoretical dollar-averaging experience in the past embolden us to predict that such a policy will pay off ultimately regardless of when it is begun, provided it is adhered to conscientiously and courageously under all intervening conditions. This is by no means a minor proviso. It pre-supposes that the dollar-cost-averager will be a different sort of person from the rest of us, that he will not be subject to alternations of exhilaration and deep gloom that have accompanied the gyrations of the stock market for generations past. This, I greatly doubt — particularly because most of the dollar-cost-averagers we are speaking of will be typical members of the public who have been persuaded to embark on an equity accumulation program by the arts of salesmanship now so highly developed in the mutual-fund field.
Let me return once again to the problem of the proper perspective for viewing the character of the stock market and the investment aspects of equity accumulation. At the outset I presented a statistical comparison of the market’s behavior over the past 12 years and over the past 90 years. But our knowledge goes back a good deal more than 90 years — a full two centuries and a half, in fact, to the inception of the South Seas Company in 1711.
In our first edition of Security Analysis, published in 1934, we characterized the stock-market madness of the 1920’s as a repetition or rerun of the famous South Sea Bubble. By comparison the behavior of our present market appears more rational, dignified and reassuring. No one today, not even ingrained conservatives such as myself, expects consequences to this market and the economy even faintly resembling the catastrophe of 1929-1932. Yet I have a feeling that the financial world has become too complacent about the future, too confident of the invulnerability of common stocks as a whole to a drastic change in their fortunes.
Fifty years ago, when I first read of economic history, there were some lines by Walter Bagehot about stock-market speculation that every student was supposed to know almost by heart. These lines, not without their dry and wry humor, read as follows:
“Much has been written on panics and manias. But one thing is certain: That at particular times a great many stupid people have a great deal of stupid money. Several economists have plans for preventing improvident speculation — our scheme is not to allow any man to have a hundred pounds who cannot prove to the satisfaction of the Lord Chancellor that he knows what to do with a hundred pounds… At intervals…the money of these people — the blind capital (as we call it) of the country — is particularly large and craving; it seeks some one to devour it and there is a plethora; it finds some one and there is speculation; it is devoured and there is panic.”
This paragraph was written nearly 150 years after the South Sea Bubble episode, and it seemed relevant to financial affairs for nearly another century to come. Interestingly enough, the South Sea Company itself had lasted almost 150 years after its disastrous beginning. I see in these dates an evidence of the persistence and repetitions of history. A great corporation can withstand great vicissitudes; the same is true of great institutions, among which not the least important is common stock investment and equity accumulation over a span of time. But a bull market has never become a financial institution, and I have great doubts whether this attractive development is an admissable possibility, when the frailty of human nature is taken into account.
My own inward picture of the present stock market is that of an institution cut adrift from old standards of value without having found dependable new standards… The market may either return to the old measures of central value; or — as is perhaps more probable — eventually establish a new and more liberal basis for evaluating equities. If the first happens, common stocks will prove highly disappointing over a long period for many accumulators of equities. If the newer and higher value levels are to be established on a sound basis, I envisage this working out by a process of trial and error, covering an unpredictable period of time and a number of pendulum swings of unforeseeable magnitude. I do not know whether bonds will do better than stocks over the next fifteen years, but I do know that the people behind College Retirement Equity Fund (CREF) are eminently wise in insisting that its beneficiaries have at least an equal dollar stake in bond as in stock investment.
A few things have changed since Graham said that in 1962. It’s much easier to make regular contributions to an investment plan that apportions money into whatever allocation the plan warrants at the time — to the point of automation. That alone might solve Graham’s warning not to forget about bonds.
Except “stupid people” with “stupid money” still exist, even ones with an investment plan.