Dollar Cost Averaging - Fact or Fallacy:

Here’s the pitch: instead of randomly investing a lump sum, just add a consistent dollar amount per month.  When the market is going down you’ll be buying more shares, at a cheaper price, and when it goes back up those extra share will be worth more.”

Sound good, makes sense but dollar cost averaging is really just a cleaver sales tool.  This was probably invented by a stockbroker, that was having trouble getting his clients to invest during down markets.  It works in a rising market.  However, even the most courageous investors don’t have the stomach for buying in a declining market, that is why it doesn’t work in the long run. 

Here is and example: let’s say that you have been following a $100-a-month averaging plan.  All is fine while the market continues to clime for the first few years.  But then it happens.  The market starts a decline and month after month it goes lower.  You still putting in your $100 per month but after looking at the losses you stomach starts to hurt.  How long can it go down?  Maybe you’ll watch you account shrink for 6 maybe 10 months but remember the average bear market last over 16 months.  Sooner or later you’ll think twice about throwing good money after bad. 

This is precisely when dollar cost averaging breaks down.  Emotionally it is too hard to see it through.  But even if you can invest after months of losses let’s look at the numbers. 

If you started with $100 and added $100 per month from 1926-2000 into the Dow Jones Industrial Average the results would look like this: