Wade into the market? Or plunge?

By Tim Middleton

With the stock market wackier than Daffy Duck, risk has risen to unprecedented levels. On Thursday, the CBOE Volatility Index ($VIX.X), which measures volatility of the prices of stock-futures contracts, soared to 80 -- the highest in its history. It's often called the fear index, and any reading over 30 is considered ominous.

That's a reason one of investing's most treasured precepts -- dollar-cost averaging, or DCA -- is finding wider and wider acceptance. You do this automatically in your 401(k), contributing a fixed amount each month, whether stocks are up or down. Thus, in a period of volatility, you spread your risk. This year, prices were down in seven of the first nine months, with extreme losses in January, June and September, not to mention the first couple of weeks of October.

But dollar-cost averaging is mind balm only. It doesn't actually reduce risk, and it doesn't increase returns.

In fact, there's evidence that investors should approach the market more aggressively. Over short periods as well as long, investing lump sums is the equal of dollar-cost averaging, except in those rare times when the market is going straight up, when lump-sum investing does better.

"At our firm, we tell clients that there is no difference," says Paul A. LaViola, the vice president of RTD Financial Advisors in Philadelphia. "However, emotionally, it can make someone feel better if they DCA when the market is going down or they are unsure about the market."

My household invests both ways, twice monthly in my wife's 403(b) and our brokerage and mutual fund accounts, and lump sums into my SEP-IRA (simplified employee pension individual retirement account) two or three times a year. My wife recently changed jobs, and we'll be rolling her old 403(b) into an IRA. It's a considerable amount, and we'll reinvest all of it. DCA is pointless, except as a crutch.

Surprising results

Don't believe me? You're not alone. "I am a huge proponent of dollar-cost averaging, especially in volatile times like we are currently experiencing," says Jane M. Young of Pinnacle Financial Concepts in Colorado Springs, Colo. "I have not conducted any studies, so my opinion is based on 12 years' experience working with clients." I can understand that financial novices -- the clients of financial advisers -- are soothed by DCA. But I have done some research, and here's what I've found:

Vanguard 500 Index Fund (VFINX) over 10 years

		Investments of $100 per month	Lump-sum investments of $1,200 per year	Lump-sum performance (compared with monthly investments)
Date	Price	Total portfolio value	Total portfolio value	Total portfolio +/-	Annual dollar +/-	Annual percentage +/-	Market performance
Nov. 2, 1998	$108.49	$100	$1,200
Oct. 1, 1999	$126.05	$1,267	$1,394	$128	$128	10.1%	16.2%
Oct. 2, 2000	$132.02	$2,521	$2,692	$171	$44	1.7%	2.7%
Oct. 1, 2001	$97.86	$2,922	$2,961	$39	-$132	-4.5%	-19.5%
Oct. 1, 2002	$81.87	$3,493	$3,410	-$83	-$122	-3.5%	-22.3%
Oct. 1, 2003	$97.19	$5,498	$5,390	-$108	-$25	-0.5%	11.8%
Oct. 1, 2004	$104.55	$7,130	$7,078	-$52	$56	0.8%	6.7%
Oct. 3, 2005	$111.30	$8,798	$8,763	-$36	$16	0.2%	2.3%
Oct. 2, 2006	$127.04	$11,324	$11,322	-$2	$34	0.3%	10.0%
Oct. 1, 2007	$142.83	$13,999	$14,053	$54	$56	0.4%	10.4%
Oct. 1, 2008	$82.87	$8,962	$8,880	-$82	-$136	-1.5%	-39.4%

Note: Figures may not add up because of rounding.

This shows the relative performance of two portfolios established 10 years ago in the Vanguard 500 Index Fund (VFINX), the investable form of the standard stock benchmark. One investor put in $100 on the first day of every month. The other put in $1,200 on Nov. 1 of each year.

Ten years later, we can see there is no significant difference in their returns, either in their total over the period or their annual performance. Even in this disastrous year, when the fund itself has gone down 39.4% in the past 12 months, the lump-sum investor did only 1.5% worse than the DCA investor. The greatest disparities in the overall portfolio were a lump-sum advantage of $171 in 2000 and a DCA advantage of $108 in 2003.

I shared my study with several financial advisers, and one raised two pertinent questions about my method: Why did I choose to begin in November, as opposed to some other month? And why did I choose Vanguard 500 rather than a surrogate for some other benchmark, such as small caps or foreign stocks?

To answer the first, I wanted 10 full years of data, as of the most recent possible date. Beginning in November 1998 allows both investors to make identical annual contributions. Further, I chose Vanguard 500 because this is the market. Most investors have the bulk of their equity assets in domestic big caps.

The adviser didn't ask why I chose 10 years as my study period, but I'll tell you anyway: It reflects roughly five years each of bull and bear markets. In fact, the current bear market and that of 2000-02 are both monsters, marked by declines of more than 40% -- the only time besides 1973-74 this has happened since the 1930s.

If anything, such extreme downward volatility should have favored the DCA investor. But it didn't.

Continued: What advisers say

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