Stock investing. Do Not Dollar Cost Average

So losers average losers. Those who agree with this statement should not invest by "dollar-cost averaging." What is dollar-cost averaging, and why is it a form of averaging losers?

Here's how an article on the Motley Fool website describes dollar-cost averaging:

Dollar-cost averaging can be a good way to protect yourself from a volatile market. It's the practice of accumulating shares in a stock investing over time by investing a certain dollar amount regularly, through up and down periods . .. The beauty of this system is that when the stock investing slumps you're buying more, and when it's pricier you're buying less.

The conventional wisdom suggests that dollar-cost averaging is a great way to invest. It often takes the form of a payroll withdrawal that is invested into stocks. Such payroll purchases are a form of dollar-cost averaging because the same numbers of dollars are invested in each period.

Sound reasonable? In fact, dollar-cost averaging is a profitable strategy as long as the money is invested into something that goes up in price persistently. In bull markets, every drop in price is an opportunity, and as the Motley Fool suggests, the "beauty" is that the investor scoops up more shares during "pullbacks."

While dollar-cost averaging works in bull markets, it is not profitable in long-term declines. Imagine, for example, what would have happened to an investor whose dollar-cost averaged into Etoys hot stock investing. Each month, as the stock price of Etoys fell, the investor would be buying more shares for the same dollar amount.
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As the Motley Fool piece suggests, it is true that "when the stock slumps you're buying more." That's great except for the fact that Etoys filed for bankruptcy; at which point the shares became worth zero.

Dollar-cost averaging doesn't work well for declining investments. The Japanese Nikkei peaked over 40,000 in 1989, and 15 years later it sits at around 12,000. So an investor who "yen-cost averaged" into Japanese stocks over the last 15 years would have been averaging losers; that is, owning more and more of a declining investment.

Even if you are optimistic that Japanese stocks will rise from current levels, you would be better off buying now. You could buy today at a much lower price than you would have paid by averaging, and you could have avoided 15 depressing, losing years.

Averaging into a declining market is a form of throwing good money after bad. If this is true, why is dollar-cost averaging so popular? The answer is that a lizard brain that has lived its entire life in a bull market loves dollar-cost averaging. In fact, the backward-looking lizard brain loves whatever has worked in the past.

In the United States , dollar-cost averaging into stocks has always paid off in the "long-run." That is because throughout history U.S. stocks have always eventually recovered and gone on to new highs. In what has been a 200-year bull market in U.S. stocks, marked by some extreme pull- backs, dollar-cost averaging has worked well. It will not be profitable, however, if stocks enter a persistent decline. Trading Price declines in secular bear markets are not pullbacks, they are just setbacks on the way to more declines.

Dollar-cost averaging is a bull market strategy. It is the equivalent of being loaded for squirrel. As long as there are no vicious bears, then being loaded for squirrel is perfect. Thus, dollar-cost averaging into U.S. stocks is a form of investing by looking in the rearview mirror. It has been a great strategy throughout U.S. history, but that does not mean that it will be a profitable strategy in the future.

Conclusion: Do not dollar-cost average. Unless you have some secret knowledge that we are not in a bear market, dollar-cost averaging can be a form of averaging losers. Remember: Losers average losers.