Let’s Talk Dollar Cost Averaging in a Volatile Stock Market

Is the dollar cost averaging strategy a good idea in a volatile stock market – like what investors are seeing in early 2018?

It’s a good question, especially when you stack DCA against lump-sum investing, as Vanguard did in a 2017 study. For the most part, lump sum investing outperformed dollar cost averaging two out of every three times, “even when results are adjusted for the higher volatility of a stock/bond portfolio versus cash investments.”

Downward volatility was certainly the case in early February, when the Dow Jones Industrial Average lost 2,400 points, or 9 percent of its total value, in 10 days. When markets are trending down, DCA enables investors to snap up shares of stocks at lower prices – even if the Vanguards of the world don’t see it that way.

“The beauty of dollar cost averaging is that it works in any market, regardless if the market is down, or the market is up,” said Ryan Repko, a financial planner with Ruedi Wealth Management in Champaign, Ill.

DCA rewards investors during a down market, because you can buy more shares since they cost less. But the reverse is true, too, Repko noted.

“In an up market, DCA protects you because your same dollar contribution buys fewer shares, because the shares are valued higher,” he said. “Thus, dollar cost averaging is a win-win because you buy the most shares when they cost the least, and you buy the least shares when they cost the most.”

'Can Be a Good Strategy'

DCA is a methodology best employed when investors believe there is a good chance that markets may move lower over their time horizon or when cash is being received by the investor in regular intervals, other experts said.

“Dollar cost averaging can be a good strategy when the near-term market direction is uncertain,” said Tracie McMillion, head of global asset allocation for Wells Fargo Investment Institute, based in Winston-Salem, N.C. “DCA may be especially helpful when market valuations are high relative to historical averages.”

That was the scenario through much of 2017 and into January of this year, however, the market pullback has led to more attractive market valuations, McMillion added.

“Those employing a dollar cost averaging strategy would be able to purchase more in today’s markets than they likely would have in January,” she noted.

If you have a lump sum of cash to invest, you can vary how you invest during your time period via DCA. But your success rate depends on how you play the market percentages, McMillion noted.

“You may want to increase the amount of your purchases when the market declines a certain percentage,” she said. “For example, you may have set aside your cash in thirds to invest over the next three months. If the market declines 5 percent, you might want to double your purchase amount and if it declines 10 percent, you might want to add in your last third outlay, effectively deploying your cash sooner than anticipated because of the market’s downward movement.”

Find the Middle Ground

To further master the fine art of dollar cost averaging, investment professionals recommend a blend of discipline and organization.

“The biggest detriment to investors is behavior,” said Joe Thomas of Thomas Financial Co. “Creating a plan that is systematic will always be the best in the long-run.”

A good start is to begin investing a certain amount or percentage of assets each month, Thomas noted.

“If the process is to be driven by market performance, having a set metric to work with or limit orders to buy at certain prices is the best strategy,” he said. “It’s easy when things are good to say you will buy if prices go down 10 percent, but it’s much harder to do when prices actually go down 10 percent and all the headlines focus on additional risks to the downside.”

Having a shopping list and setting prices you’d buy at before a downturn will make this approach more systematic, Thomas added.

“If one is consistently saving for retirement, put money in at regular intervals and consider adding more money if the market drops a certain percentage (say 10 percent),” he said. “A systematic, non-emotional plan that is crafted prior to market turmoil should provide the best results.”

There are other ways to leverage market volatility to buy into the market at lower prices.

“Besides dollar cost averaging, investors may want to consider rebalancing their portfolio allocations when the markets are volatile,” McMillion said. “That’s because market movements can cause your asset allocation to diverge from your long-term targets. For example, when the equity markets are declining, bond prices usually are more stable. You may want to sell some of the bonds to bring your equity allocation back up to its longer-term target weight.”

By doing so, in effect you are “buying low and selling high,” she said.

DCA Not a Timing Mechanism

As always, nothing is really black and white when it comes to leverage-seeking stock market investment strategies like dollar cost averaging.

“Market downturns are precisely the reason for and the engine behind dollar cost averaging,” said Rob Drury, executive director at the Association of Christian Financial Advisors. “It’s the lows that bring down the average cost of the investment and mitigate market risk.”

That said, the very idea of a "DCA strategy" or "DCA opportunities" violates the premise of dollar cost averaging, Drury said.

“The success and the safeguards of dollar cost averaging rely on consistent participation regardless of market activity; the reason being that the investor cannot reliably predict market movements,” he noted. “If one attempts to ‘time’ actions while dollar cost averaging, one is defeating the purpose of DCA.

“In reality, one is absolutely not dollar cost averaging at all, as one's success relies on timing rather than taking equal advantage of upward and downward movements,” Drury said.

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected]