What Can We Learn From Black Friday and Dollar Cost Averaging In Your 401(k)?

The Friday after Thanksgiving is called Black Friday because this is the day that retailers typically go into the black (positive earnings). Jay Leno called it black eye Friday because people go crazy on this day and people get in fights or trampled on just to get the 20% off sale item. It is crazy with people lining up at 2 or 3 am to get an item on sale.

The ironic part about this yearly ritual is that people rush in for 50% off bargains but when it comes to stock sales they rush to the exits. The Dalbar study of Investor Behavior (which is on our website) shows a dramatic underperformance by the average investor as compared to the S&P 500. The average investor underperformed the market by over 5.03% for the 20 year period ending Dec 2009. The reason for this is because investors run to the exits when stocks are on sale and rush to enter the market after stocks have gone up. This is the exact opposite of what the public does on Black Friday.

How do you remedy this situation? You have to have a plan and have discipline. If you can't provide your own discipline, then you should have a wealth manager to provide the discipline you need to be successful. Dollar cost averaging can help smooth out the ups and down along with a diversified portfolio.

We did a dollar cost averaging study using 3 different global funds of varying stock and bond mixes. We looked at the implications of dollar cost averaging $1000/mo starting very near the top of the market. We studied the results using a 100% global stock fund, a fund that is composed of 60% stocks and 40% bonds and a fund the has 25% stocks and 75% bonds. Dollar cost averaging $1000 per month is very similar to what you do in your 401k. The results were surprising.

The period covered was from Nov 07 to Oct 12 - 60 months. The total investment was $60,000 in each fund. Transaction fees were ignored.  Here is what we found:

Fund Fund allocation Investment per month Total  Investment Investment worth as of 10/31/12 Investment Return (Final value/total investment) Fund Return (if you invested at the beginning only)
DFA Global 25/75 I 25% stocks/75% bonds $1,000 $60,000 $69,034.38 15.06% 19.38%
DFA Global 60/40 I 60% stocks/40% bonds $1,000 $60,000 $72,155.69 20.26% 9.60%
DFA Global Equity I 100% stocks $1,000 $60,000 $73,299.80 22.17% -5.98%

As you can see there is a huge difference between the investment return and the fund return. There is almost a 30% gap between the fund return and the investment return for the global fund (100% stocks) and about an 11% gap for the 60/40 fund. This is because of the nature of dollar cost averaging a set amount each month. When you invest a set amount each month, you buy more shares when the fund price is lower and fewer shares when the fund price is higher. Then when the fund rebounds it works out to your advantage.

Obviously, looking back this would have been hard to start and continue during the whole period. It is hard to focus on the long term when there is a barrage of media reports that the world is going to end. That’s why having a plan and discipline can lead to a successful investment outcome.

 

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

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