Indexfundfan\’s blog (new URL is Indextown.com)

April 16, 2006

Benefits of DCA: Forget cost savings, think risk reduction

Filed under: Investing — indexfundfan @ 9:35 pm

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 figure below shows the volatility reduction (according to the author) due to averaging:

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