In my post about beating the S&P 500, I mentioned regular contributions as a factor that helped me. Over the weekend, I examined precisely how regular contributions helped. This led me to the subject of Dollar Cost Averaging (DCA), which until recently I thought was the same as regular contributions. They are not!
DCA and regular contributions are similar in a sense that an amount of money is added to an investment portfolio on a regular basis. However, with DCA it is an intentional act of investing only a small part of a lump sum; whereas there is no lump sum involved with regular contributions.
Based on my research, DCA — at least the way that brokers try to sell it — is just a gimmick to get nervous investors to take the plunge. DCA actually does not work all that well and only works if the market is volatile or trending down. However, the market has been trending up as long as it has been in existence. Because of this upward trend, you almost always come out ahead investing the entire lump sum at the beginning.
This is the chart from “Introduction to CAGR,” showing S&P performance for the past 30 years.
Take a look at the scenarios below.
So in my case where I contributed to my 401k twice a month, regular contributions really did help me between 2000 and 2007. Regular contributions (not DCA) has many merits:
Here are some more about dollar cost averaging: