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Dollar Cost Averaging | Does DCA Work in 2020? - YouTube
Channel: Stock Investment Analysis
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You cannot time the markets. It's
impossible. So how should you decide when
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to buy? Many people suggest dollar cost
averaging, but is dollar cost averaging
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the best strategy? Look across the sea of
YouTube videos, and you will see many
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people telling you dollar cost averaging
is the best strategy. Is that true? Watch
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this video to the end and you will learn
what dollar cost averaging is, what lump
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sum investing is, and which is better.
This video will be 100% based on
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research with real numbers and the
results will surprise you. To explain
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dollar cost averaging, let's use an
example. This is Ben, and he has just
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inherited ten thousand dollars.
He watched my last video on timing the
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markets which is linked above so he
knows that you can't time the markets.
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He recognizes he therefore has two main
options: he can invest all ten thousand
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dollars right now or he could space it
out over time. For example, he could
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invest one hundred ninety two dollars
and thirty one cents every week for the
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next year. Which is better? The answer
depends on what the markets will do that
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year, but Ben knows there is no way to
predict this with any certainty. Since he
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can't be certain what the markets will
do, he chooses to invest one hundred and
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ninety two dollars and thirty one cents
each week for the next fifty two weeks.
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He won't get the best possible results,
but he won't get the worst results
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either. This is called dollar cost
averaging because he's averaging out the
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cost of his investments over the course
the next year. Maggie received ten
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thousand dollars as a bonus from work.
She is faced with the same dilemma. She
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also knows she can't time the markets,
but unlike Ben, she knows the average
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total S&P 500 return from January 1871
to july 2019 was point zero two three
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nine percent per day or about nine point
zero nine percent per year. She figures
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that if the average year results in a
nine percent return she should get all
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her money invested and working for her
as fast as possible. She invests all ten
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thousand dollars immediately. This is
called lump sum investing because she
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invested all of her available money for
investing in a lump sum. Let's imagine in
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this scenario that the year Ben and
Maggie invest is consistent with the
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average year. The results of Ben's and
Maggie's investing strategy show Maggie
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comes out ahead by
$451.25 after the first year because
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her investments had more time in the
market. Maggie and Ben compared their
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investments and Ben is surprise by how
much Maggie outperformed him. He argues
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that although she beat him this year,
it's only because she got lucky. What if
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the markets had dropped right after she
had invested? Most of the time, dollar
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cost averaging is the right choice. If
they did this a few more times, he would
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come out ahead.
Maggie pulls up some research to educate
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Ben. In actuality, lump-sum investing in
the S&P 500 beats dollar cost averaging
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over a 24 month period in seventy seven
point eight percent of all months from
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1997 to 2018. To help you understand this
chart, when the black line is above the
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midpoint, it is showing months in which a
24-month dollar cost averaging strategy
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would have beaten lump sum investing. When
the line is in the bottom half of the
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chart, it is a time that lump sum investing
performed better. You can see lump sum was
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better more than three-quarters of the
time and dollar cost averaging was only
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better during the financial crisis and
when the dotcom bubble burst. If we go back
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even further and look at 1960 into 2020
in this chart, lump sum investing is
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still better in 73.7% of all months, and
it is even better in 100% of all
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months if you take a moment to like this
video. These videos take a lot of time to
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research and create, and hitting that
button will help the YouTube algorithm
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get this video out to more people who
are interested. Ben next argues that
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maybe lump-sum investing is better for
the S&P 500
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but for investing in general dollar cost
averaging is still better.
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Maggie shows Ben this table. From 1997 to
2020, dollar cost averaging
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underperformed on a 24 month basis
between 58 to 90 percent of the time
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across emerging markets, Bitcoin, all US
stocks, gold, Treasuries, and a 60/40 stocks
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to bonds split. In fact, the longer the
period of dollar cost averaging, the more
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certain it is that lump sum investing
will prevail. Research conducted by
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Vanguard and the S&P 500 have found that,
over a 36 month interval, lump sum beat
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dollar cost averaging more than 90
percent of the time
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whereas it only beat dollar cost averaging
about two-thirds of the time over twelve
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months. Ben countered, pointing out that
in the data Maggie showed him there was
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more volatility in the returns for lump
sum investing which makes it riskier and
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a poor investment strategy.
Maggie explains that if he's worried
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about risk he can invest sixty percent
in the S&P 500 and 40% in bonds and
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still outperform dollar cost averaging,
achieving a point five percent monthly
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return instead of a point three percent
monthly return. Not only that, but as can
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be seen in this chart, the volatility of
both methods is identical at two point
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three percent over this time period.
Maggie points out that this means lump
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sum investing is still better and she
can achieve superior returns with the
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same volatility. Frustrated, Ben tells
Maggie that she needs to consider
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valuation. What if she had invested when
the markets were already overvalued? If
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the Shiller p/e ratio is high, he would
have beaten her. The Shiller p/e ratio is
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a measure of valuation which takes
inflation and the business cycle into
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consideration. Ben notes the ratio only
went above 30 twice prior to recent years.
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Once in 1928 before the Great Depression
and in the late 1990s before the dot-com
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bubble burst. With this ratio rising
again, he will win next time.
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Ever the astute investor, Maggie breaks
down some numbers for Ben. If they had
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both used their strategies with $100,000
beginning in any month between 1926 and
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2018 in which this ratio was above a
thirty two, lump sum investing still
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would have won 60 percent of the time.
People often employ dollar cost
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averaging because they know they can't
time the market. Ironically, if you think
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dollar cost averaging is better than
lump sum investing, you are still trying
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to time the market. As demonstrated in
the research in this video, lump sum
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investing is almost always better than
dollar cost averaging. If you want to
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wait until the right moment or want to
dollar cost average because you feel it
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is the wrong time, you are trying to time
the markets and will usually lose money.
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As a result, what should you do instead?
If you have money to invest, invest it. It
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is as simple as that. Only invest the
money you don't need for other purposes,
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but if you have the money, invest it.
Don't wait. The sooner you have your
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money working for you,
the sooner
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you will reap the rewards of those
investments. Have you been dollar-cost
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averaging? Has any of this changed your
opinion? Leave a comment below. I would
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love to hear from you. Also, please
subscribe to this channel because I will
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be creating new videos for you every
single week. As always, good luck with
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your investing.
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