Dollar Cost Averaging (DCA) – Beginning Investor Terms
Posted on | January 13, 2010 | No Comments
Dollar Cost averaging is one of those perennially stupid ideas like Efficient Market Theory, that is so dumb, that I wonder how anyone could buy into it. It is completely contrary to the logic of Value Investing. But my opinion aside, it is a popular idea among investment advisers, so good to know what it is.
Dollar Cost averaging assumes that since we can’t know the direction of the market we should continue to invest the same amount of money spread out over a particular period of time. It works like this: you put $100 every month into GE stock regardless of the price, so that over time, theoretically, you are lowering the overall price basis you pay for a stock. Investopedia says, “Eventually, the average cost per share of the security will become smaller and smaller. Dollar-cost averaging lessens the risk of investing a large amount in a single investment at the wrong time.” This of course assume that stock prices are moving up over time.
Really? What if GE stock is overvalued two months into this investing plan? Who wants to invest at the top of the market? You might as well say buy high, sell low. No one knows with certainty the top or bottom of a market, but anyone can determine whether or not buying particular stock, at a particular time is a good or bad deal, the current price is above or below the intrinsic value of the stock. If GE is a bad deal why would you dollar cost average? Avoid the stock. If it is a good deal why would you dollar cost average? Load up the truck. Warren Buffett, according to Alice Shroeder, the biographer of “Snowball,” said that Buffett doesn’t support Dollar Cost averaging. Me either.
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