Dollar cost averaging is widely promoted by advisers, media sources and investment companies as the preferred method of investing for retirement. The idea is to spread your investments out over time, rather than investing your money all at once.
Because most investment in the Thrift Savings Plan is through payroll deduction, dollar cost averaging is the strategy for most participants’ retirement savings. However, it is possible to be faced with a choice of whether to invest your TSP funds all at once, or to spread your investment across a number of days, weeks, months or years.
Recently, I’ve been getting questions about dollar cost averaging from TSP participants who have moved large portions of their TSP accounts into the G Fund and are considering moving the money back into the C, S or I funds. This is a specific example of a broader question – whether it’s best to rebalance your account’s allocation among the various funds all at once, or a little at a time.
Let’s take a look at how dollar cost averaging works and consider the various choices and potential outcomes. Say you have $1,000 to invest and want to buy shares of the C Fund. You’re considering whether to invest the entire amount today, or to invest half of it today and the other half in a month. Basically, there are three scenarios that might play out: The price of C Fund shares could increase during the coming month; the price could remain the same; or the price could fall. To illustrate:
- If, in the first scenario, the price of the C Fund rises from $10 per share to $20 per share, and you invest the entire $1,000 at once, for $10 per share, you will have purchased 100 shares at an average cost of $10 per share. If, instead, you split the investment in half, purchasing 50 shares at $10 per share, and 25 shares at $20 per share, you will have purchased 75 shares at an average cost of $13.33 per share. In the case of rising market prices, the advantage goes to lump-sum investing.
- In the second scenario, where share price stays constant at $10 per share, investing all at once produces an average share price of $10. Splitting the investment in half produces the same $10 average cost per share. In the case of flat market prices, dollar cost averaging offers no advantage over lump-sum investing.
- In the third scenario, let’s assume that the price of the shares falls from $10 to $5 at the end of the month. Investing all at once produces the same $10 average cost per share that we saw in the first scenario. In this scenario, splitting the investment in half will mean that you’ll purchase 50 shares at the beginning
of the month at an average cost of $10 per share. At the end of the month, you’ll purchase 100 shares at $5 per share for a total of 150 shares and an average cost per share of $6.67. In the case of falling market prices, spreading out your investment to take advantage of dollar cost averaging produces the better result.
In two of the three possible scenarios, dollar cost averaging produces results – an average cost per share – that are inferior to or no better than lump-sum investing. Yet, many investors believe that dollar cost averaging offers some inherent advantage over investing everything up front.
If you accept, as logic and history indicate, that investment results are largely unpredictable in the short run, then delaying investing to benefit from dollar cost averaging is a poor bet. In fact, since markets are generally more likely to rise over the next month, year or decade than they are to fall, you’re more likely to benefit from lump sum investing in the appropriate investment allocation, than from the dollar cost averaging alternative.
Written by Mike Miles
For the Federal Times
Publication April 27, 2009