Fribble Dollar-Cost Averaging:

An Excellent Investment or a Big Surprise?

R ecently, I began to wonder, does dollar-cost averaging really work? The argument is, put a regular amount in a stock on a regular basis. As the share price drops, you buy more shares. As it goes up, you buy fewer. Makes sense, doesn’t it? Is your annualized return higher this way? Fact or fiction?

The math isn’t too difficult; it’s about 10th grade level. It isn’t a whole lot of fun though. You have to calculate the return for every month you’ve invested, and annualize it. Kind of like the assignment I would have gotten in 10th grade for thinking about my girlfriend, K.C. in class when I should have been paying attention. How could I help myself? Blonde hair, blue eyes, her perfume. I better stop; it won’t be Brother Albert I’ll be in trouble with this time, it’ll be Barbara.

Anyway, getting back from 10th grade, what did I do? I used to sneak out and go down to the Washington Monument. Oh, with the stocks. I’m sorry. I made up a spreadsheet of the 30 Dow Jones Industrial stocks, using their monthly prices from the past 3 years. I calculated what the annual returns would be monthly if you put in $100 a month for each of those three years. I also calculated your annual return if you put that $3,600 in all at once in the beginning of the 3-year period. I then calculated how much you would have at the end of the period both ways. I averaged the whole thing up to see how well this works. As you should be able to tell, it wasn’t a pretty sight.

So, what does this tell you? I know, I shouldn’t be allowed near spreadsheets. My cousin Clarence the Farmer always said, there’s nothing more dangerous than an engineer with a spreadsheet. Barbara’s going to ask me if he really said that. No, not really. He actually said something about being locked in a barn with coyote with rabies was a little dicey, but I’m digressing again.

Getting back to the subject. Dollar-cost averaging doesn’t really give higher annualized returns for the Dow stocks in the last three years. It may work better over a longer cycle, where somewhat of a bear market may have occurred. This surprised me. How many Fribbles have I written that praise dollar-cost averaging of DRiPs? Dollar-cost averaging is common wisdom that nobody ever bothers to check. The calculations are horrendous, requiring all kinds of roots to be taken, summations, averages, etc. Possibly over longer term it may work; I’ll work the spreadsheet again to see what we can get over a longer period, but that will be another Fribble.

What was the very worst stock to dollar-cost average? Ignoring Bethlehem Steel and its negative returns, McDonald’s was the worst. The average return from dollar-cost averaging is 1.55%. If you put all that money in at once, you would have made an annualized 15.77%. That also under-performs the market. Throw in high fees for the DRiP plan and other problems of late at the burger giant, and you would have to look at it twice. Westinghouse has an even lower return from dollar-cost averaging, but the difference between that and investing $3,600 all at once is less (1.34% vs. 12.47%).

What was the best? Phillip Morris. You get a 42.41% return by dollar-cost averaging, vs. 38.69% if you invested all that money at once. Apparently, the volatility caused by the anti-smoking initiatives helps your return. Of course, that depends on how you feel about tobacco stocks.

Even though dollar-cost averaging may not give higher returns, investing money as it is available into DRiPs is certainly a good way to invest. However, if you have a large sum of money to invest, I would think twice about dollar-cost averaging it. In the meanwhile, stay out of barns with rabid coyotes.