Can Perfect Market Timing Beat Dollar Cost Average?
Why People Should Not Stay In Cash
Cash is like a safety blanket that keeps you warm in cold winter nights. During market downturns, many people are keeping cash to deploy “when the time is right”. But how would you know when the time is right? If you’re one of those who can, that’s great. For most people, however, timing the market bottom is a futile effort, as numerous studies have shown.
2 Groups of Investors
In investing, there are 2 groups of people.
The first group is the DCA folks, where they put aside a sum of money to invest each month. No matter whether the market goes up or down, this group buy into the market consistently. This allows them to buy more shares when the market is low, and less when the market is high.
The second group is the Buy The Dip folks. This group manages to time the market to perfection, buying on dips just before the market starts to shoot up again.
Buy the Dip vs. DCA over every 40-year period
Dollar cost averaging (DCA): You invest $100 every month for 40 years.
Buy The Dip: You Save $100 each month and only buy when the market is in a dip. A dip is defined as when the market is not at an all-time high. Not only will you buy the dip, but you will know exactly when the market is at the absolute bottom between any two all-time highs. This will ensure that when you buy the dip, it is always at the lowest possible price.
Buy the Dip underperforms DCA in more than 70% of the 40-year periods starting from 1920 to 1980.
You should invest as soon and as often as you can. If you had picked a random month since 1926 to start buying a broad basket of U.S stocks and kept buying them for the rest of the following decade, there is a 98% chance that you would have beaten sitting in cash and an 83% chance that you would have beaten the 5-year Treasury notes. More importantly, you would have earned about 10.5% on your money while doing so.
If you were to run a similar analysis for a group of global stocks since 1970, you would have beaten cash in 85% of 10-year periods and earned about 8% on your money.
Why Does Buying the Dip Underperform?
For a very simple reason. In the long run, markets tend to trend upwards. In most cases, the next market dip will be higher than the previous market dip. This is why we see underperformance even when timing the market with greatest accuracy,