In a sense, Dollar Cost Averaging is a refuge for scoundrels. Numerous studies have shown that in addition to lowering overall returns, DCA does not even meaningfully reduce risk when compared with other strategies-even a completely random investment strategy. Dollar Cost Averaging has been widely criticized by economists and academic finance researchers as more of a marketing gimmick than a sound investment strategy. Now let’s talk about why this process of buying more shares as the stock goes down IS NOT the same as dollar cost averaging.ĭCA means investing a fixed dollar amount at fixed intervals no matter what the price of a given stock might be. Instead of making $20,000, you’ve made $260,000 because you have trained yourself to stockpile wonderful businesses. In the second example, because you stockpiled the stock as it went down, you have $30,000 invested, which you’ve turned into $260,000, with a return of 54% per year. But look at the difference to you: In the first example you doubled $10 to $20 and made a 15% compounded return. Five years later, sure enough, it’s selling for its value of $20 per share. The average price you paid per share is $2.30. You now own 13,000 shares and have invested $30,000. But, your company still has a $20 per share long-term value by virtue of its potential for future earnings. Maybe the whole stock market has just fallen off the table, the Dow is down 85%, and no one wants to own stocks. Again, we’re assuming the business hasn’t changed at all-you know it hasn’t because you’ve gone through the Four M’s carefully. In six months you’ve saved another $10,000 to invest, so you look around and discover that the price of your favorite business continued to fall to $1 with a Payback Time of two years. The only difference might be a better Margin of Safety. When I say there is “no change in the long-term value” I mean you’ve double-checked your Four M's analysis to ensure the value of the company still stands as you first calculated it at the first buy-in.
But in this case, let’s say the price of the business has fallen to $5 per share (with no change in the long-term value of $20) and it has Payback Time of five years, so now you buy 2,000 more shares. You own 1,000 shares at $10 and now it’s six months later and you have another $10,000 to invest. Now let’s compare this result with another scenario. You are priced out of this stock.Īt the end of 5 years, the stock price is still at $20, and if you decide to sell you’ve doubled your money and made a 15% annual return on your 1,000 shares. That means that you can’t buy any more with your $10,000. Nothing has fundamentally changed in its long-term value, but it no longer has the Margin of Safety or Payback Time we’re looking for. But now it’s priced at $20, with a Payback Time of 13 years. Six months later you’ve managed to save another $10,000 and are looking for something to invest in, so you reconsider this business you love. You have $10,000 to invest and you buy 1,000 shares. Payback TimeĪssume that you find a business you really understand with a great Moat and Management you can get behind.Īssume it has a conservative value of $20 a share, it’s selling for a Margin of Safety price of $10, and it has a Payback Time of eight years. Therefore we want the price of any business or stock we stockpile to stay low so we can buy more of that great company at even better prices over and over. We know we’re investing for many years into the future. We’re not expecting to cash out today or tomorrow. If prices go down, but we know what we’re doing, our net worth is going to go up big-time. But remember, our net worth is not about prices, at least not in the short term. And a small piece of the right business at even better prices will make you rich over time.Įven after you buy into a business, you want the price of the part you don’t own, the part you haven’t bought yet, to go down. You might not be able to buy the whole thing, but you can certainly buy a piece.
Breaking Down Dollar Cost Averaging - DCAįor Rule #1 investing, you already know what price you are willing to pay, so Dollar Cost Averaging isn’t necessary.Įvery day there are wonderful businesses that you can buy on sale. What's your Investing IQ? See how you stack up against other investors.
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