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How Did Dollar Cost Averaging (DCA) Fare Over The Past 100 Years? February 16, 2012
Using the wealth of historical data available for the US market, we assess how a dollar cost averaging strategy fared over the past century
Author : iFAST Research Team


How Did Dollar Cost Averaging (DCA) Fare Over The Past 100 Years?

 

Key Points
  • We looked at the US market as a proxy for stock market returns; our 100-year study encompasses the period between 1912 and 2011
  • Over 5 years, positive returns were achieved 87.6% of the time; utilising DCA over 25 and 30 year periods generated positive returns in every instance
  • Average annualised returns for a DCA strategy (over 5, 10, 15, 20, 25 and 30 years) were between 5.4% and 6%
  • Historically, DCA has been a good approach to building up a long-term investment portfolio; however, investors who have a larger sum for investment should put their money to work sooner rather than later
  • Highlighting the advantages of staying invested, “lump sum” investments over a similar time frame delivered average annualised returns of between 9.9% and 13.5% respectively

Having written much about the benefits of a regular savings plan (RSP) which utilises the concept of dollar cost averaging (DCA), investors may be curious to know how well (or poorly) DCA actually fared in the past, based on actual stock market returns. To answer this, we turn to the wealth of historical data available for the US market.

Methodology and Assumptions

Using Robert Shiller’s data for US stock market prices (which spans back to 1871), we adjusted the US stock market index for dividends (to achieve returns on a total return basis), and used this to test the performance of a DCA strategy over the past 100 years. To achieve 100 years of test results (from 1912 to 2011), market return data as far back to 1882 (30 years prior to 1912) was utilised so that 30-year rolling-returns could be calculated for initial periods of our study.

We assume an investment is made at the end of each calendar month, and selected rolling 5-year, 10-year, 15-year, 20-year, 25-year and 30-year periods as our test cases. Returns are calculated at the end of the plan (on an annualised basis) on the entire amount of money invested, but we did not consider additional interest on funds which had not yet been invested (to simulate the actual experience of an investor who begins investing with little starting capital). As an example, a 30-year $100 per month DCA plan which began in December 1981 would have seen $36,000 invested over 30 years; the investment was worth $174,064 at the end of the plan (as of end December 2011), for an annualised return of 5.4%*.

*(174,064 / 36,000)^(1/30) - 1  =  5.4%

Study Result: Longer-term DCA plans performed better

Table 1: Investment returns for a DCA Strategy (plans ending 1912 to 2011)

Investment Period

Maximum

Minimum

Average Return

Probability of Positive Returns

5 years

19.8%

-19.4%

5.4%

87.6%

10 years

15.2%

-6.2%

5.5%

96.3%

15 years

11.8%

-1.7%

5.6%

99.5%

20 years

11.2%

-0.1%

5.8%

99.9%

25 years

10.9%

0.7%

5.9%

100.0%

30 years

10.0%

1.2%

6.0%

100.0%

Source: Robert Shiller, iFAST; returns are annualised, in USD terms and include the reinvestment of dividends

As shown in Table 1, DCA strategies demonstrated a relatively high probability of positive returns. A 5-year DCA plan delivered positive returns 87.6% of the time, while implementing DCA over 25 years and 30 years generated positive investment returns in every instance. The outperformance of longer-term plans was not limited only to the probability of positive returns; over longer periods, the lowest return achieved was superior, while the average return achieved was also better. Chart 1 and Chart 2 show the returns of various DCA strategies over time, based on ending periods.

Chart 1: Historical Dollar Cost Averaging Returns (5- to 15-year periods)

Chart 2: Historical Dollar Cost Averaging Returns (20- to 30-year periods)

RSP works, but un-invested funds entail high opportunity cost

Our simple study on historical DCA returns over the past 100 years suggests that a regular savings plan (RSP) is a good approach to building up a long-term investment portfolio, especially when the plan spans a longer period of time. From our perspective, RSPs are highly suited for investors who have little starting capital, bringing about the benefit of maintaining a disciplined saving approach, as well as continuous participation in the market.

While an RSP has its benefits, we still maintain that investors who have a larger sum for investment should put their money to work sooner rather than later; this would entail a “lump sum” investment rather than spacing out the investment via an RSP (see “Introduction to Portfolio Management” for a guide on asset allocation). The key reason for this is the high opportunity cost of un-invested funds, which can make a significant difference to investment returns, especially over the long term.

“Lump sum” investments delivered superior returns

Table 2: Investment returns for a “lump sum” investment (plan ending 1912 to 2011)

Investment Period

Maximum

Minimum

Average Return

Probability of Positive Returns

5 years

33.7%

-17.3%

10.0%

87.7%

10 years

21.2%

-4.0%

9.9%

95.8%

15 years

19.3%

-0.4%

10.0%

99.9%

20 years

24.6%

2.7%

13.5%

100.0%

25 years

21.8%

4.8%

12.4%

100.0%

30 years

17.4%

4.4%

11.6%

100.0%

Source: Robert Shiller, iFAST; returns are annualised, in USD terms and include the reinvestment of dividends

As Table 2 highlights, long term “lump sum” investments delivered much stronger returns, ranging from 9.9% to 13.5% (in contrast to the 5.4% to 6% returns delivered by DCA strategies), exemplifying the high opportunity cost of keeping funds un-invested. While a few percentage points may not appear like a lot, Table 3 highlights the high opportunity cost of un-invested funds by simulating ending dollar amounts of a 30-year investment of $10,000 with varying returns.

Table 3: Theoretical Returns after 30 years of investing

Invested Amount

Annualised Return

Ending Portfolio Value

$10,000

5%

$43,219

$10,000

6%

$57,435

$10,000

7%

$76,123

$10,000

8%

$100,627

$10,000

9%

$132,677

$10,000

10%

$174,494

Source: iFAST

The range of average historical returns achieved in our “lump sum” study is also consistent with our view that long-term equity market returns are driven primarily by earnings growth (about 7.1%, the long-term historical growth rate of corporate earnings in the US) and dividends (which has averaged about 4% over the past century), which together provide a total return of about 11% a year (see “How Does One Predict Equity Market Returns?”). In addition, over periods of 20 years, 25 years and 30 years, staying invested throughout delivered positive returns in every instance, making the case for long term investing.

Implications for investors

Our study highlights that dollar cost averaging has been a relatively successful approach over the past 100 years, making it a useful strategy to accumulate wealth over time. Interested investors may wish to visit Fundsupermart Regular Savings Plan to find out how to embark on an RSP. Nevertheless, investors should note that an RSP may not be the most suitable approach for their investment requirements if they have a larger sum of capital to begin investing with. For such investors, a suitable portfolio allocation should be decided upon based on risk and return considerations, and funds allocated in a “lump sum” approach rather than via an RSP.

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