Andrew Stotz 00:01

Andrew, fellow risk takers, this is your worst podcast host Andrew Stotz from a Stotz Academy, continuing my discussion with Larry swedroe, who for three decades was the head of Research at Buckingham wealth partners. You can learn more about his story in episode 645, now Larry stands out because he bridges both the academic research world and the practical investing world. And today we're diving into a chapter from his recent book, enrich your future, the keys to successful investing. And specifically, we're going through chapter 26 and the title is dollar cost averaging. Larry, take it away.

Larry Swedroe 00:35

Yeah, this is one of my favorite topics, because it attacks a myth and investing that most people believe and lots of advisors push, and there is a little bit of good news on this story here, but it's mostly a behavioral benefit, not a reality that's a good investment strategy. So there's an interesting question that many people face. They get an inheritance, maybe their parents died, something like that. They sell a company, and now you've got, you know, cash. What do you do? Do you invest it all at once in your asset allocation, whatever it might be? Or do you put the money in what some people call dollar cost averaging. Other people say drip by drip. Just, you know, enter the market, and that way you avoid these big crashes. You're the using a Yiddish expression, you're the chamele or the shelmazo that the day you invest the market's going to crash, which is exactly what everyone is afraid of, right? Okay, so this question was studied very simply a paper written by a University of Chicago professor in the 1960s named Constantinides. And he said, It's dumb. Logically, it's dumb. It makes no sense from a expected return outcome. Okay, and he said very simply this, ask yourself, are stocks riskier than safe bonds? What's the answer? Riskier? They're riskier. That's why stocks have what's called an equity risk premium, right? It's true every single day, right? So every day you're out of the market, you're giving up an expected return. And therefore, and if you run the empirical data, look at various periods, and the vast, vast, vast majority of the time, you're ahead if you put the money all in at once. So the logical answer, from a purely financial perspective, must be, if I have money to invest, I should always invest it whenever it's available. End of discussion. Now, academics love to publish papers showing somebody else is wrong. In 60 plus years, no one has published a paper saying this is wrong, which gives you a hint that maybe Constantine 80s was right, and there are studies showing that, of course, he's right. Now, if you inherited the money on March, 1 of 2000 or October, 2007 of course, in hindsight, you would have been better off dollar cost averaging, but bear markets are infrequent, and therefore clearly the majority of the time you're going to be well ahead. The sales pitch is often, but you buy more shares when prices are down, so you should be ahead, but the math is wrong. It's just again, this simple common sense that every day there is an equity risk premium, and therefore every day you're out of the market, you're missing out on expected but not guarantee returns. In my books on financial planning, including my only God, you'll ever need for a successful and secure retirement. I point out that there is a psychological benefit, and where I would advise people to at least consider dollar cost averaging, but it's only for the people who are so afraid that they're the unlucky soul that the day they're going to put their money in the market will crash, or their biases, their view your Democrat and the US and Trump gets elected, and you're sure because of your bias. Prices that the stock market will crash, or if you were Republican and Biden got elected, or Obama, you're sure the Democrats will screw the economy up. So you don't invest. Okay, so you have your biases that could overcome. If that's the case and that prevents you from investing, then every day you're out of the market, you're giving up expected return, and you could be out a long time. Now, imagine it that Trump gets elected, and you're a Democrat, and the market goes up, as it did in 2016 now it's higher, but you didn't invest. In fact, maybe you sold the markets higher. How could you buy? Now, prices are even higher, and if it went down, you can't buy because you're sure it's gone lower. So once you make the decision not to buy, for whatever the reasons, it's very difficult to get know when to get in. It often will happen months or years later, after the market has gone straight up for some long period of time. So what I tell people is this, if you can't get over that bias, because you're concerned greatly, or you're sure you're the unlucky soul that the day you invest it's going to crash, here's what you should do. Take a piece of paper, write down a plan. I don't care what it is, just don't make the time frame very long. You could say, I'm going to put in 1/3 of my money every month for the next three months, 1/6 every six months, one quarter every quarter for the rest of the year. Don't make it more than a year, because most bear markets don't last that long. And then here's what I want you to do, if the market goes up, congratulate yourself for your brilliance, for at least investing one quarter, 1/3 1/6 Okay, and avoided not investing at all. And if the market went down, congratulate yourself on your brilliance, for avoiding putting all your money in at the same time. Either way, you were a genius, and you feel good about yourself, even though it was the wrong answer from a purely financial perspective, but we are human beings subject to behavioral biases, and if you know you're one of those people, then having $1 cost average plan that you write down and absolutely commit to turn it over to your Financial Advisor, your brother, your sister, a friend, and say you are to execute. And if I try to tell you to do something else, you have my permission to hit me over the head and go ahead and execute it anyway.

Andrew Stotz 07:53

There's a couple of things that I was thinking about when I people ask me about this all the time and and I say, for most people, they're going to dollar cost average. And the reason is, they don't have a lump sum. For most, that's right, I get, you know, people get monthly income, and you should just be constantly trying to get your money into the market to get that long term equity exposure. So congratulations, you are probably doing dollar cost averaging. I would

Larry Swedroe 08:27

say you're changing the phraseology. What you're doing is investing whenever you have cash, which is what I tell people do, you are not dollar cost average, right? You're not.

Andrew Stotz 08:38

You only got $10,000 but I said I was only invest 1000 No, put the 10,000 in.

08:43

That's it. Yeah, that's different.

Andrew Stotz 08:44

Always build your exposure to equity. You know, as early as you can in your life, you can never, no method of investing will beat that, because ultimately that ends up being a large amount of money early on in your life that's able to compound and get that equity return?

Larry Swedroe 09:03

Well, I would just change what you said a little bit. I would not say no method of investing would beat that. Putting all your money at once gives you the best odds of having the most money. But imagine an investor in Egyptian stocks in 1900 or Japanese stocks in 1990 clearly, they were better off dollar cost averaging, but that's in hindsight. So it could work. But if you want to put the odds in your favor, which is the best we can do, because we don't have clear crystal balls, you should put all your money in whenever you have it to invest.

Andrew Stotz 09:44

Yeah, and let's say that you've already worked out. I think you know one of the key things is working out the instrument or instruments or methodology that you're following. Is that just a simple index fund? Is it a US index fund? Is it a global index fund? Is it a combination of that? At plus some of the factors that you know, exposure that you built. But once you've got that set, then you know. Now what we're talking about is you know where to go now. So first thing, as I said, many people don't really even have this choice because they don't have a lump sum. So really, what we're talking about is people who have a lump sum. And the point is that lump sum should would always benefit over time if you put it in now, let not just go

Larry Swedroe 10:30

back again. You're it's giving you the best odds of success. It's not a guarantee to be the best strategy, but we don't want to confuse strategy with outcomes or engage in resulting. If you put it in all at once, that's the right strategy, because the best you could do is put the odds in your favor if it turns out to be March 1 of 2000 you got bad luck. Doesn't mean it was the wrong strategy,

Andrew Stotz 10:58

and that's where, you know, people like to think they have more control over the market, and they because we're talking about another element, which is the element of, I'm going to time the market. Yeah, okay, if you think you're going to do and when you talked about your solution, as you mentioned about, okay, fine, come up with a one year plan that's not for the purposes of timing the market. It's really for the purpose of overcoming your behavioral

Speaker 1 11:25

Yes, exactly right. Yeah, okay, exactly right.

Andrew Stotz 11:29

And I was just looking at the research on dollar cost averaging, and you highlight that in there, but I was just going back that that paper by Constantinides was in 1979 nobody, okay, yep, nobody gains from Dollar cost averaging was in 1992 that's Mandel Knight. And Mandel the fallacy of dollar cost averaging in 1994 by Thor Lee, a continuous time re examination of inefficiency of dollar cost averaging in 2003 and that was mill Veski and Paul Posner. And another look at dollar cost averaging in $2,018 cost averaging the trade off between risk and return. And now, well, I remember many, many years ago reading a book called Value averaging, and somebody has come up in 2011 with enhanced dollar cost averaging, and in 2023 we have smart DCA superiority. Any thoughts on those?

Larry Swedroe 12:27

Yeah, the answer is simple, if you believe markets provide a risk adjusted return or not, okay, it's like saying this, if the PE ratios are high, you shouldn't invest. Well, that turns out to be wrong. It just means that the equity risk premium is smaller, but there's still an equity risk premium. It goes to our same argument we discussed last week on the Sell in May strategy. Yeah, stocks do perform worse from May through October, but there is still, in fact, they perform about half as strong as they do the first the other six months, but there's still an equity risk premium, so you're better off investing. Like I said, there's not a paper that I'm aware of anyway that contradicts Constantinides paper, which was done almost 50 years

Andrew Stotz 13:29

Yeah. Ma'am, excellent. Well, that's a great discussion on dollar cost averaging. I know for some people, they haven't thought about it in detail. This gives you some background on how to think about it. Larry, I want to thank you again for another great discussion, and I'm looking forward to the next chapter. And the next chapter is chapter 27 Pascal's weight. Wag, wager, sorry. Wager, yeah, wait and the making of prudent decision, Pascal. Is he the guy that said that I would have written you a shorter letter, but I didn't have the time.

Larry Swedroe 14:09

I don't know. He may have been, I think he was a French mathematician. Yes,

Andrew Stotz 14:14

I think he was, but I'll have to check that by the time we meet again. Alright,

Larry Swedroe 14:18

we'll discuss his famous analogy, which teaches people how to think about wagers or investment decisions, or any decision, if you'll remind me, I'll tell you the story about how what I did when I gave each of my daughters was old enough to drive a car and and we'll use the Pascal's Wager to explain their behavior.

Andrew Stotz 14:47

Perfect. I look forward to it. And ladies and gentlemen, you can find Larry on X Twitter, at Larry swedro, and also on LinkedIn. This is your worst podcast. Was Andrew start saying, I'll see you on the upside. You.