Dollar Cost Averaging (DCA) involves investing a fixed amount at a regular interval. Lump-Sum Investing (LSI) involves putting in all the money you have available to invest at once. These are not mutually exclusive! If you are investing a portion of your paycheck every month, you are both Dollar Cost Averaging and Lump Sum Investing. The following is not about such habitual savings.

However, a different situation arises if you have a larger amount of money. Maybe you received an inheritance, an early retirement payout, or you just sold your house. Do you invest the entire amount immediately, or buy a little at a time? Due to the overall upward trend of the markets, lump-sum investing outperforms DCA about 2/3rd of the time. The argument then, is that DCA is a risk-reduction mechanism; You get less performance, but also less exposure to those ups and downs. But is DCA the best way to lower risk?

This question was examined in this academic paper titled Nobody Gains from Dollar Cost Averaging by Knight and Mandell. Here’s a sample of their results. Let’s say you have $100,000 to invest, and you want to achieve a portfolio of 90% stocks (modeled as the S&P 500) and 10% bonds (T-Bills). But that sounds risky to you. You decide to instead invest gradually over 10 years, every month putting a little bit more in, until you finally put $90,000 into stocks.

But what if you instead put everything at once into 50% stocks and 50% bonds, and kept those 50/50 proportions for the entire 10 years instead? That would also reduce your risk. You may be surprised to find out that historically the 50/50 rebalanced portfolio actually had the same amount of volatility than the 90/10 dollar cost averaged portfolio, but with a higher average return (8.37% vs. 8.05%).

So if you are keeping money out of the market because you don’t want to be exposed to a crash, it may simply be better to invest in a less aggressive investment mix. But if you are already regularly investing what you can each month, keep it up! This doesn’t apply to you.

For more academic papers on why DCA is not the best way to reduce risk, see this AltruistFA reading list. Thanks to reader Craig for sending me this article.

For my overall thoughts on investing for beginners, please see my Rough Guide to Investing.

Now how about a snapshot of our investments, as of the end of the day 12/15. Remarkably, our investments have increased $4,911 (7.3%) since my last update in October. Another example of how I can’t predict the stock market. We’re already done contributing to our Roth IRAs and 401ks this year, so we haven’t made any new deposits. Everything has been going into the house down payment fund.

I did realize that I’m not including my Bridgeway investments in my net worth calculations. This is because Bridgeway does not work with Yodlee, and I never remember to log into their website. Oops!

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(Note: This is an older post from my archives, and was last revised in 2007, so some things may be out of date. Please check out my investing guide for more recent material.)

Although I get asked regularly to do so, I’m always wary of making specific investment advice . I’m haven’t passed any securities exams, and I have no financial letters after my name like CFA, CFP, CIC, or ChFC. I’m just a SRDO – Some Random Dude Online.

At the same time, I also appreciate the fact that people like to hear some specific suggestions in order to jumpstart their own research. It’s like being told “go buy a good used car” versus “check out the 2002-2004 Honda Civic (7th Generation, but not the 1st year) with less than 60,000 miles on it.” It’s not the perfect answer for everyone, and you may not even buy that car, but it gives you something to work with.

With that in mind, this is what I would tell my sister to invest. Not you, because I don’t know you. 🙂 She’s in her early 20s, recently out of college, working in her first professional job, and trying to balance renting in a big city, being young and trendy, paying back student loans, and oh yeah! – also retirement. She’s busy, doesn’t feel like reading the books I recommend just yet, but has some extra money now to put away for the future. So what does big bro tell her?

Get investing! You need to do this now so you can:

1. Reduce your risk in the long run
2. Get used to the ups and downs of the stock market (so you don’t just bail out later).

Option 1: No Money Down?
Set Up An Automatic Transfer at TIAA-CREF or T. Rowe Price

If she’s doesn’t have much to start with but is willing to set aside $50 every month, you can open an account at T. Rowe Price or TIAA-CREF with no initial investment minimum. If you’re in your 20s, look at the T. Rowe Price Retirement 2045 fund (TRRKX) or TIAA-CREF Lifecycle 2040 (TCLOX). Both seem to be solid companies with good customer service. They will get you “in the game”, are very low-maintenance, and will leave you with plenty of time to refine your tastes afterwards.

The good thing about starting low is you’ll get gradual exposure to the volatility of the market. In the beginning, it took me a while to get used to the fact that my balance could easily be much lower than it was yesterday. That can be very disconcerting for those only used to bank accounts.

Option 2: Think Long Term
Open Up An Account at Vanguard

I make no secret that I really like Vanguard. They have reliably low expenses, are fair and upfront about their fees and how they are compensated, and they are client-owned. Although they may have some higher fees in the beginning, I believe that over the long run their low expenses and indexing-expertise will result in superior performance. This is a company that I can see sticking with for the next 50+ years. So here’s one strategy using Vanguard for any account size:

Less Than $1000 – If she has less than $1,000, I’d tell her to just stick it in a high-yield savings account. Set up some automatic transfers from her checking account after each paycheck, and start building that up until you have…

$1000-$3,000 – Here, the only fund that’s available is the Vanguard STAR Fund (VGSTX). You can open up with $1,000 to start and add in $100 more at a time. It’s an okay fund, currently with 63% stocks, 25% bonds, and 12% cash. The point isn’t to get the perfect asset allocation right away, it’s to get get started. Again, see the two main goals above.

$3,000+ – When you get to this amount, exchange your shares into the Vanguard Target Retirement 2045 Fund (VTIVX). Since it’s in an IRA, there are no tax consequences or paperwork to worry about. See my post comparing Vanguard and T. Rowe Price Target funds for why I like it the best.

For all Vanguard IRAs, there is a fee of $10 a year for each fund account with a balance of less than $5,000 (waived with high overall balances). Use the $10 as a specific savings goal – “I will eat out one less time this week, saving $10”. Then write Vanguard a check for the $10 separately, so it’s not taken out of your Roth IRA balance. You want all that money compounding away! These fees are now waived with e-statements!

With all of these options, it is always a good idea to set up automatic transfers to avoid the “I forgot again because I was busy” factor. Also, feel free to call any of these companies on the phone. You should get a helpful human quickly, I always do with Vanguard.

Anyways, I hope these suggestions provide some good starting points for your own research. I sure hope my sister listens to me! As always, comments are welcome.

The prospect of losing your hard-earned money is scary. You know that if you invest with $1000 in stocks, in a year you could be left with either a huge gain or a huge loss. People (including me in the past) tend to look at the stock market like a slot machine:

This is good in that, yes, for the short-term the stock market is risky. Don’t put money you may need right away into stocks. However, when young people tell me that they are putting their Roth IRAs in a bank CD because they are afraid of the stock market, that is bad. Roth IRAs are long-term investments. We’re talking 30, 40, 60 years for some people! The way you should be looking at the stock market is this:

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Target-dated retirement mutual funds are getting more and more popular, offering instant diversification into stocks and bonds, as well as automatically shift to a more conservative blend as you near your target retirement date. An all in one fund! Whenever you see a finance article talk about the “best” of these mutual funds, invariably Vanguard and T. Rowe Price top the list. Recently, Kiplinger’s Personal Finance magazine named T. Rowe Price “the best Target fund available”. I’ve been meaning to do my own personal (and imperfect) comparison for a while now.

What makes a fund good?
First, why am I picking these two to compare? If you’ve read the books on my reading list, you’ll know that history and research has shown that the two most important factors that predict long-term performance are:

1. Asset class – What is the fund invested in? Large-cap domestic stocks? Short-term bonds?
2. Expense ratio – How much is the mutual fund company charging for its services?

Vanguard founder John Bogle sums it up well:
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Ever since exchange-traded funds became popular, many index fund investors have taken notice. Should we try to take advantage of the often-lower expense ratios? Can we overcome the commissions from trading? For example, both of these track the S&P 500 index:

IVV – iShares ETF, expense ratio of 0.10%
VFINX – Vanguard Mutual Fund, expense ratio of 0.18%

I just ran across this article at IndexUniverse.com, which compares the performance of mutual funds vs. ETFs for various indexes.

The general conclusion was that the main ETF for an index outperforms the average mutual fund tracking the same index. However, if you choose the Vanguard fund version, you will get very similar or sometimes even better performance due to their superior index management. [Read more…]

Back in May, legislation was passed that allows Traditional IRAs to be converted to Roth IRAs without any income restrictions in 2010. Previously, this conversion was only available to taxpayers with adjusted gross incomes of $100,000 or less, no matter if you’re married or single. You even get two years to pay the taxes on the conversion. One of the more detailed articles I’ve seen written about this change is this USA Today article.

Another side effect of this new law is that it opens up a gaping loophole so that allows anyone to contribute to an Roth IRA, albeit indirectly:
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