My Dollar Cost Averaging experiment
Opdateret: 20. apr. 2021
Many investors are using Dollar Cost Averaging (DCA) as a method in their investing. I decided that I would be your guinea pig and use a DCA strategy on the S & P 500 index.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money.
First a short explanation of what Dollar Cost Averaging (referred to DCA in this post) is. DCA is a strategy of buying stocks, mutual funds or other assets every month with the same amount of money, regardless of the price of that asset. One example could be that you invest $100 every month in Apple. If the price goes down you get more shares and if it goes up, you get less shares. In theory this should neutralize short-term volatility and remove the concern of timing the market.
Personally, it is not a strategy I normally use as I consider myself as a value investor, and I do not want to buy an overvalued asset. In his book "Payback Time" Phil Town wrote this about the DCA strategy: "Dollar Cost Averaging is stupid. It's a brain-dead way to buy into a business or an index. The fact that it appears to be a simple and effective way to avoid buying at a bad price makes it a great tool for clueless financial experts". Later in this post I will mentioned some of the risk and bad examples of DCA, which might explain what Phil Town meant with that statement.
If you follow or copy me, or if you have gone through this website you know that I regard Phil Town very highly. Nevertheless, I have decided to continue with this experiment for you guys, in order to give you a real life example of DCA. I feel fine about it as I use the extra income I get by working a few hours a month at either Appen og Clickworker, hence it is psychologically easier for me to spend the money on a strategy I do not really believe in, as it is done with extra funds I did not expect to have to begin with. I should also mention that this experiment is not done through my popular investor account, so my copiers will not be affected at all by this experiment.
In order to begin with this project, I had to decide in which asset I should do my DCA experiment in. It was pretty clear from the beginning that I did not want to do it with an individual stock. I had two options in mind and they were the ETF called QQQ (which tracks the Nasdaq 100 index excluding financial companies) or one that follows the S & P 500 Index. Later I will give you a bad example of the QQQ, so I decided for to go with the broader S & P 500 Index.
I actually started this experiment in July but before we go through that, I will explain the background of my decision for this experiment first. I looked into the numbers and if you had followed a DCA strategy on the S & P 500 index with $100 dollars a month in ten years starting July 2010 and ending in June 2020, the numbers would be as following:
These are not bad numbers at all and made me a bit more encouraged about starting my experiment. In order to get started I had to find a ETF that mirrors the S & P 500 index. At eToro there are two well known ETF's that do so and they are called SPDR S&P 500 ETF Trust (SPY) and Vanguard S&P 500 ETF (VOO). In order to decide which of the ETF's to use for my experiment, I had to see where they differentiate from one and another. As both mirrors the S & P 500 Index I found that the only major difference was the expense ratio, where VOO costs 0,03 % and SPY costs 0,09 %. Because of the difference in their expense ratio I preferred to go with the cheaper option being VOO.
So I decided to get the experiment started on 27th of July 2020 where I purchased my first $100 worth of VOO. However, when I thought about it, I realized that remembering to buy $100 worth of VOO the 27th in every month, might be not be as easy as a round number, hence I decided that I would do my DCA strategy the 10th in each month, meaning I bought my next share of VOO the 10th of August. If the 10th in a month is a Saturday, I will buy VOO on Friday the 9th and if the 10th is a Sunday, I will buy it Monday the 11th. This is how it will work from now on. We are now 3 months into the DCA experiment and my shares in VOO are worth $301 from $300 invested:
I mentioned previously that there are some risk involved with the DCA strategy and I would like to go through some of the examples here. The market can end up going sideways for a very long time. If you had used a DCA strategy on the Dow Jones Industrial Average Index from 1905 to 1942, your rate of return would have been 1 %, from 1965 to 1983 it would be 2 % and 2000 to 2005 it would be 3 %, these returns do not even beat inflation. I know that many investors look at tech now, so let me tell you why I did not choose to do my DCA strategy in the QQQ ETF. Let us say you invested $100 a month in QQQ from 1999 to 2009, you would have invested $12.000 with an average price of $47. In March 2009 QQQ would be priced at $27, and you would have lost 43 % of your investment after 10 years! I know that it would eventually go up again but that would be hard to stomach and your investment would have been put to better use in other assets.
So this is my experiment and I'm curious to see where it leads me. I will do some updates every now and then in order for you to follow my progress. It is a bit strange to follow a strategy I do not agree with but hopefully I will learn something and I hope that you will too.