Benefits of DCA: Forget cost savings, think risk reduction

Many investors are familiar with the concept of DCA (dollar-cost averaging) and this technique is sometimes said to offer cost savings (i.e. lowering the cost basis of the investments).

The paper Lifetime Dollar-Cost Averaging: Forget Cost Savings, Think Risk Reduction by Robert Dubil in the FP Journal however argues that

… the cost benefit of dollar-cost averaging (DCA) is dubious, since one cannot predict the path of prices. But, the risk-reduction benefit of DCA is real: averaging over time is akin to buying less-than-perfectly correlated assets. This produces a lower volatility of the terminal value of the investment — that is, a more certain outcome.

The figures below shows the volatility and risk reductions (according to the author) due to averaging:



Value averaging

The topic of value averaging came up again (49263) on the Diehards forum. From Marshall’s Spring 2000 paper “A STATISTICAL COMPARISON OF VALUE AVERAGING VS. DOLLAR COST AVERAGING AND RANDOM INVESTMENT TECHNIQUES“:

According to Edleson [3], the idea behind VA is simple. The investor sets a predetermined worth of the portfolio in each future time period, as a function of the size of the initial investment, the size of periodic investments and the yield expected. The investor then buys or sells sufficient “shares” or units of the investment such that the predetermined portfolio worth is achieved at each revaluation point.

Here’s the conclusion of the paper:

Results strongly suggest, believe it or not, that value averaging does actually provide a performance advantage over dollar-cost averaging and random investment techniques, without incurring additional risk.