Friday, May 7, 2010

Dollar Cost Averaging with SPY

I wanted to take a more definitive look into dollar cost averaging. Admittedly, the first time I explored dollar cost averaging, I picked a relatively new index fund without much history and the price data was gathered very roughly by manually reading values off a Yahoo! Finance Chart.


This exercise in the merits of dollar cost averaging use actual historical price data, ranging from January 1993 to April 2010, for the SPY index fund, which tracks the S&P 500. I wanted a more in depth view of the differences in yearly lump sum investing and monthly dollar cost averaging. What I found was that when the lump sum investing continues at a regular interval for several years – it becomes just another form of dollar cost averaging. The important point being the regular interval which occurs on autopilot and is not subject to our personal fallacies encountered in market timing. In summary, the plots that follow will illustrate that the normal investor can still dollar cost average even when there is only one investment per year. Think of the brokerage fees saved! Unless, of course, you are trading your ETF's for free already.


Dollar cost averaging works on whatever schedule that you can afford to set up. The smaller the frequency, the smoother your curve will be. 

The other point that this plot serves to illustrate is the basic premise behind dollar cost averaging. Every period you invest a set dollar amount. When the market is high, you buy fewer shares, but when the market is low, you buy more shares.
Date# of Shares Purchased

I'd like to focus this next portion on just the last ten years, or what many people like to call "The Lost Decade". I have found that many market analysts like to point out that if you had invested $1,000 in April of 2000, it would only be worth $949 today. Ouch! Why should we invest then?

While this statement is true, it should not bother the slowly marching forward dollar cost averaging portfolio owner. Why? Just take a look at the next chart that shows what each $1,000 contribution made to your total investment portfolio over the last 10 years.

Or, if you prefer, a nice pie chart.



The moral of the story: Slow and steady wins the race. The years the market was down the most, 2003 and 2009, are the years that contributed the most to the success of this fund. The years the market was up the most, and when herd mentality was gathering in more and more investors, in 2000 and 2006-2008, are the years that contributed the least to the success of this fund.

1 comment:

  1. Thank you for taking the time to share this research!



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