For many investors, the practice of dollar cost averaging is almost an unconscious one, such as the periodic contributions made to retirement plans, like a 401(k), which happen whether the market is rising or falling. However, when it comes to managing a lump sum, the choice to average it in or dump it in, is up for debate.
While much research has been done on the matter, Sam Stovall, chief equity strategist, SP Capital IQ takes a more pragmatic approach to the problem of whether to lump it in.
“That depends,” says Stovall in the attached video, who studied the issue back to 1999. While his research found that dollar cost averaging actually led to higher returns for index investors, many other types of investments actually did worse.
For example, Stovall says if you put $10,000 into the SP 500 on December 31, 1999 and then added $1,000 at the start of each quarter, your $58,000 would have grown 30% to $75,611. However, had you put the full $58,000 in at once, you be up only on 16% to $67,247.
Next, Stovall used the same approach with different investments, specifically the SP Dividend Aristocrats portfolio, and the results were shocking. The average investor grew his portfolio 86% to $108,000, whereas the lump sump buyer had grown his holdings by 155% to $148,332.
There are at least two lessons here. First, being in the right type of fund is as important as even being in the market. Second, as Stovall points out, indexes with higher dividend yields and lower volatility are much better suited for lump sum investing.
“You end up with the power of compounding, plus they have a much lower beta than the market as a whole, so their wiggle factor is a lot less,” Stovall explains.
The flip side is that the higher the volatility and lower the yield, the better off you’ll be following the averaging approach.
As far as how best to take money off the table, or to try to better time when to buy dips, Stovall offers up “the 7% solution” which plays off the mathematical anomaly that the average decline of dips, corrections and bear markets since World War II is 7%, 14% and 28% respectively.
“All are multiples of 7, so you could say at each 7% decline threshold, I will then add more money,” he says.
As for the here and now, Stovall thinks it will take a few more attempts but, eventually, the Dow and SP 500 will break through their current resistance levels and move on to new highs.