by Ed Elfenbein | November 19, 2010 12:01 pm
Burton G. Malkiel, the author of A Random Walk Down Wall Street has an op-ed in today’s WSJ defending buy-and-hold investing.
While I also advocate buy-and-hold, my take is very different from Malkeil in that I favor holding a microscopic part of the market. He favors holding the whole thing. I change one-fourth of my Buy List each year which means that the average holding period is four years.
In the op-ed, this passage caught my eye:
While no one can time the market, two timeless techniques can help. “Dollar-cost averaging,” putting the same amount of money into the market at regular intervals, implies investing some money when stocks are high, but also ensures some buying at market bottoms. More shares are bought when prices are low, thus lowering average costs.
There are two notions about dollar-cost averaging (DCA). One is that most investors make regular additions to their portfolios. People are paid in fixed amounts, so they invest that way. I don’t have a problem with that.
However, there is another notion that DCA is somehow inherently a less-risky way to invest. I’m not sure which notion Malkiel is referring to, but I want to be absolutely clear that the second notion is complete and total nonsense.
There is absolutely no inherent advantage in dollar-cost averaging over lump-sum investing. ZERO. Spreading out your investments over an extended period doesn’t decrease your risk one bit. The idea has been thoroughly refuted, yet the myth won’t die.
The advantage of dollar-cost averaging was blown to smithereens over 30 years ago in this article by George Constantinides. Here’s another article on the subject by John R. Knight and (my former finance professor) Lewis Mandell.
Lump-sum investing is the best. Don’t diversify by time, diversify by assets.
Ed Elfenbein is editor of Crossing Wall Street, a Web site about stocks and the market designed to help individual investors. Check out his free Buy List of stock recommendations.
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