FinTekNeeks

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Why I Hate Dollar Cost Averaging

Posted in Trading

The following article covers trading financial securities, such as stocks. The world of trading often comes with rises and declines of securities, and most things do not rise or fall in a straight line. By the time this article is published, circumstances involving what we mention may have changed. Often, changes in securities can be to the detriment to the traders – seldom is it beneficial. A person should only trade with money that they’re willing to lose because losses are guaranteed. By reading this post, you agree that you’ve read our disclosure.

Introduction

Many financial advisers suggest a technique called “dollar cost averaging” for their clients and for Americans, this is considered “acceptable advice” in the financial industry, so you should stop reading if you think this is the best advice, as I will be presenting my own reasons why I don’t always use this technique. I can think of a few cases where dollar-cost-averaging is a good technique, but in most cases, in my view, it’s not the best technique. The premise behind dollar cost averaging is that timing a market is hard, so you should just buy at whatever price over the long run and the average price of the instrument you’re buying will work out in your favor.

Example of Dollar Cost Averaging

A simple example of how this works is if Bob were to do this with the SPY every month for six months and makes 6 buys for one share of SPY at the price of 200, 200, 210, 200, 210, 210, Bob’s total purchase price would be $1230, but his overall investment would be valued at $1260 since he owns 6 shares of the SPY at an ending price of $210.

Dollar Cost Averaging Is Not For Me

Because I accept the view of Austrian economics, in some cases, I find dollar-cost-averaging inappropriate because of its major assumption: it’s pretending that the price of an item or security doesn’t matter. Austrian economists make it clear that prices reflect value – an expensive price is a signal that there is a problem, according to Austrian economics. Most people tend to think that their stocks rising are a good thing, but a rapid rise is more of a concern than a positive event, because it often is an asset bubble being created and these are dangerous. In order for businesses to be valued at such high evaluations, they must sell more and more expensive goods, which squeeze consumers out of the market. The only acceptable rise of a stock is if the company increases productivity or innovation; everything else might be indicative of price fraud.

For an example of this, when stocks were at a bottom in 2009, over the next eight years they rose from that bottom. But few stocks rose because they actually innovated or increased productivity; the majority of stocks rose because of QE and the threat of negative interest rates. Most companies in the United States produce absolutely nothing of value; for instance, look at Snapchat and Twitter – these companies would cease to exist immediately if interest rates were 10%. What feels “low-risk” is actually very high risk because interest rates price risk; if interest rates are 0 or very low, that’s like stating that no risk or low risk exists. This is impossible in reality.

Even though most stocks have performed poorly, outside of speculation from printed money, a few stocks had several thousand percent returns against the S&P 500 since 2009 because these companies actually had value and increased both productivity and innovation. If prices don’t reflect either, then the price is fraudulent, which is incredibly dangerous because either a correction or bankruptcy will reveal the truth. The most obvious example of this was SunEdison when it went bankrupt: some people were shocked at this, but this company only existed in the first place due to low interest rates.

In the same manner, bitcoin rising because of innovation or productivity is positive; rampant speculation? Inappropriate because often new people get sucked into taking massive losses. As we’ve made clear on FinTekNeeks, we do our best to try to be as honest with readers as possible so that they can avoid losing money on what we think are bad deals (see our list of accurate predictions and warnings).

In addition to the above point, when someone tells me that “You can’t time markets” they’re arguing from a complete straw man position. Do I need to time at the exact bottom or at the exact top to trade well? No. I can ask myself this question, “Is what I’m buying at an all time high or near an all time high?” If the answer is yes, or is close to it, I’ll find something else that’s cheap. Something is always cheap just like something is always expensive. Everything that rises will fall, and everything that falls will rise, and everything that rises or falls does not rise or fall in a straight line. There are 0 exceptions to this rule on a long enough timescale.

I love it when people pretend like this can’t be known. For an example, the below was an actual exchange I once had:

Average Person: But how do you know if gold is at an all time high?
Me: what’s the all time high price of gold?
Average Person: like $1800-1900.
Me: what’s the price now?
Average Person: $1700. But at $1800 it may have gone up even higher, so that may not have been its all time high even when it hit that price.
Me: Do you grasp what you’re saying?

Using the example of bitcoin, imagine bitcoinaries buying bitcoin at the all time high of $30, right before this article was written. You would be right to say that they would be richer today because bitcoin is even higher. This is true. However, they could have waited because any rapid rise will also have a rapid fall at some point. If I recall, bitcoin fell to a price of less than $10 when that article was published and this would have been an even better opportunity to buy. In almost every case, if something is at an all time high – even if it goes higher briefly – it will experience a correction. Again, you don’t need to be a genius to get this.

Finally, we’re not stuck with one option. I haven’t owned the S&P 500 in a while and have no interest in owning it. There are so many better deals out there and the S&P 500 has only risen 9% since I sold back then. By comparison, several of my active mutual funds have had much higher returns even when subtracting fees, and these are “generic” funds; some sector funds since that time have risen over 200-600%. On an individual level, some stocks are up almost 1000% over the same time and none of these are from the cryptosphere.

Where Dollar-Cost-Averaging Is Beneficial

While I find dollar-cost-averaging at any price inappropriate in most cases, it makes sense for a person who may not have the time to consider his investments. Asking a few honest questions about prices does take a small fraction of thought and work; people who hate both would probably be happier with dollar-cost-averaging as they could continue their amused investing (amuse means “to not think”). When considering that entrepreneurs must spend hours thinking about their business, I understand why many entrepreneurs prefer amused investing – they prefer investing their time and energy on creating solutions.

Another situation where dollar-cost-averaging is appropriate is during a massive decline. If a market falls 50% or more, rather than trying to time the exact bottom of the market (next to impossible), it makes sense to dollar-cost-average the cheap prices. An example of this using the SPY, would be if the market crashed 50% to 110 and rose and fell above that price for a few months, ranging from 95 to 120, due to the already cheap price, it would be efficient to dollar-cost-average at that discounted price. The reason that this approach makes sense is because I’m dollar-cost-averaging well below the security’s all time high.

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