Dollar Cost Averaging Will Not Protect You

Rule #1: The Simple Strategy for Successful Investing in Only 15 Minutes a Week!
by Phil Town

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Although dollar cost averaging (DCA) is technically not a myth, I get a lot of questions about it and constantly have to prove to people that DCAis not the investor's lifesaver it's purported to be. A favorite sales tool for fund managers and brokers, DCA is the strategy of buying stocks or mutual funds every month with the same amount of money, regardless of the price of the stock or fund. For example, you buy $100 worth of shares in Microsoft every month, no matter what the price per share is. So if the price is down, your money buys more shares. If it's up, your money buys fewer shares. The objective of dollar cost averaging is to minimize your investment risk by making the average cost per share of stock smaller.

This method of protecting yourself has two huge flaws: In a long sideways or down market, DCA is pretty much the same as buy-andhold; and for DCA to work, you have to put in the same amount every month, no matter what. So between 1929 and 1930, when $100,000 of stocks became worth $10,000, you'd still have needed to be willing to buy in. Between 2000 and 2002, when the tech stock index lost 85 percent of its value, you'd have needed to be willing to keep buying all the way down to the bottom. First, that assumes you have a job and the spare cash to spend on stocks during a recession or depression, and, second, it assumes you'd still be willing to throw in good money after taking that kind of a loss. Instead of trusting DCA, Rule #1 investors know the value of a wonderful business and buy it when it's undervalued. In other words, as I'll shortly show, we buy one dollar of value for fifty cents and repeat. We do not buy one dollar for ten dollars and hope our profligacy will be counterbalanced by an opportunity to sometimes - maybe - buy the same stock for an inexpensive price.

[With DCA from 1905 to 1942, your rate of return in a Dow index fund would have been 1 percent as opposed to zero percent with buy-and-hold. From 1965 to 1983, your rate of return would have been 2 percent instead of zero percent. From 2000 to 2005, your rate of return would have been 3 percent instead of 0 percent. In other words, over the majority of the last 100 years of stock investing, it would've been better to just buy a government bond and forget about it than to DCA in a Dow index fund.]

Because Rule #1 investors require a 15-percent return, we have to throw out strategies that fail to achieve that minimum in all kinds of markets. And because DCA failed to achieve even treasury bond rates of return in several sideways markets in the last 100 years, it cannot be a useful Rule #1 strategy.

The truth is, the financial services industry cares about your money only because it takes commissions and fees whether it makes you any money or not. It perpetuates the Three Myths of Investing and extols the virtues of dollar cost averaging so you and I will give managers our money. The last thing they want is for you to invest successfully on your own. They want you to believe you'll lose your money if you do this yourself. They're hoping your fear of loss will compel you to keep giving them your money in spite of the likelihood they'll be less effective than you are in reaping a high return.

The Three Myths vs. Rule #1

Myth: It's hard and it takes too long.
Rule #1: It's simple, taking at most only 15 minutes a week.

Myth: You can't beat the market.
Rule #1: You can take advantage of regular mispricing to reap a 15-percent return or more.

Myth: Diversify, buy, and hold
Rule #1: Buy a dollar for 50 cents, and sell it later for a dollar. Repeat until very rich.

Copyright © 2006 by Phil Town.

About the Author

He isn't your typical Wall Street guy. An ex-Green Beret and former river guide, Phil Town is a self-made millionaire several times over and America's most widely sought-after speaker on investing. In his new book, RULE #1, he describes the Rule #1 personal financial strategy in detail so that anyone, even first-time investors,can get - and stay - rich.