Dollar Cost Averaging Amid Downturn

Dollar Cost Averaging Amid Downturn

This is a big issue for many of you right now. I know you are alarmed by what is happening in the economy, and terrified by what is happening to your savings. There is a lot of talk about the "worst case scenario," which historically was the collapse of 1929-1932. During that period the Dow Jones Industrial Average fell a simply stunning 89%, from peak to trough, and did not recover all its lost ground until 1954. To put that into context, a similar fall today would take the Dow down to about 1600.

At times like these it can be incredibly difficult to stick with your long-term investment plan. Nothing like this has happened in 80 years, and even long-standing market veterans are badly shaken. Many of you have simply given up. Yes, you know the time to buy shares is when shares are cheap. You may even concede that shares are probably pretty cheap now. But who has the stomach for yet more losses? What if things get a lot worse?

Investing by dollar cost averaging can help a lot. This simply means that you put exactly the same amount of money into mutual funds or shares every month. When markets are up, you get a little less. When markets are down, you get a little more.

When you choose to dollar cost average you are giving up any attempt to time or catch the absolute bottom of the market. Most investment veterans see that as a huge plus. Few if any fortunes have been made by those who tried to catch the falling knife. Legions have been lost. Dollar cost averaging will also underperform a bull market. If shares simply skyrocket over the next twenty years, the most money will be made by those who invested all at once at the start. But that's a big gamble.

To see how dollar cost averaging might have helped an ordinary investor during the worst meltdown in history, I looked at data from the Great Depression. (My data source was Ibbotson Associates, founded by Yale professor Roger Ibbotson and now part of Morningstar.) And I looked at total shareholder returns, which includes reinvested dividends, for a basket of the top 500 companies on the market.

At the worst moment in the crash of 1929-1932, someone who dollar cost averaged had still lost about two-thirds of his or her money.

That is plenty scary. Terrifying, even. But before you bolt from your mutual funds, never to return, let me add several things.

First, these are the numbers for the unluckiest investor - the guy who began dollar cost averaging at the absolute worst moment in history, namely Sept. 3, 1929. Those who started later in the crash did at least slightly better.

Second, the performance in real terms wasn't quite as bad as it seems. That's because of deflation - the phenomenon of falling prices that helped cause the crash in the first place. A dollar in 1932 bought a lot more than a dollar in 1929: Average prices fell by about a third. So in real terms even the unluckiest investor - one who started in September 1929 - was only down, at the low point, by just over a half.

Third, they recovered fast. When the market turned, those who stuck quietly to their plan got repaid quickly. Forget that stuff about 1954. According to Ibbotson data, someone who dollar cost averaged was back on level terms by 1933. And by 1936 he had doubled his money (though the crash of 1938 then knocked him back to evens for a while).

Incidentally, while Wall Street plummeted 89% at its lows, overseas markets did not do quite so badly. They fell, overall, about two-thirds according to data from Philippe Jorion, an economics professor at University of California-Irvine. That's still bad, but it is very different from 89%.

It's an argument for sticking to regular investments through this crash: Not bailing, and not jumping in with both feet either. The simplest strategy worked; investing the same amount, every month. It's also an argument for investing globally, and not just in the U.S., which is a lot easier to do today than it was in 1929.

Oh, one more thing. Someone who started in September 1929 and invested $100 a month, every month, in Wall Street for 30 years got rewarded in the end. His total investment came to $36,000. The size of his nest egg by 1959: An extraordinary $411,000, or more than 10 times as much.