One of the perks of dollar-cost averaging is that it comes reasonably close to ensuring that your investment will generate returns that correspond to the actual growth of the company that you choose to invest in. The protection of a dollar-cost averaging strategy is that it protects you from the consequences of accidentally investing at a market high.
Take something like Coca-Cola. From 1997 to 1999, the company traded at obscene, impossible to justify valuations. It peaked in 1998 when Coca-Cola regularly traded at over 50x earnings. Someone who purchased $54,000 worth of the stock in 1998 wouldn’t have done all that well, turning his money $78,000 today for a return of 2.40% annually. However, you would be lucky that you made money at all, because you would have been paying $35 or so for a share of stock that was only pumping out $0.71 in annual profit. Those shares were worth $15 per share, yet people were paying a premium of over twice what the shares were worth. You can’t get rich with blue-chips by paying doubled (and then some) valuations like that.
If you instead started investing $300 per month in Coca-Cola in 1998, and continued through 2013, then you would be sitting on over $115,000 today. You would have more than doubled your investment. But most importantly, you would have roughly had annual returns that mirrored the growth of the company: somewhere in the 9% range for each.
Normally, investing in a lump sum (if you have the opportunity) is going to be better than dollar cost averaging. That is because of the time value nature of compounding assets. Even if you overpaid for a stock fifteen years ago, it still gets 180 months to let earnings growth and dividend growth work its magic and create wealth. That’s just how productive business that churn out profits work.
Meanwhile, someone that decides to chop that $54,000 into little bitty pieces to be invested in $300 increments over 15 years is going to be held behind by not having his money put to a productive use. When you delay investment, some of that capital doesn’t get deployed into 2010, 2011, 2012, and so on, and the less time you have to compound, the less wealth you will end up with.
Unless a stock is excessively overvalued, it usually makes sense to invest what you got at a given moment.
When you dollar cost average for ten, twenty, thirty years, into a particular stock, then you are putting yourself into the position of capturing the growth of that company over time. If Coca-Cola grows earnings per share over the next 10 years at a rate of 9% annually, and you dollar cost average during every month over that time, you will likely capture 9% total returns unless the company spent an extended period of time overvalued or undervalued (which is unlikely).
The thing about Coca-Cola is that, despite its size, it still has one of the most reliable records of 9-12% annual earnings per share and dividends per share growth rates in the world of publicly trade stocks. There aren’t that many companies that balance growth and high quality quite like Coca-Cola. In an unpredictable world, there aren’t a whole lot of no-brainer options where you can say, “I think I can compound my wealth automatically at 9-12% annually for twenty years running.” Coca-Cola is one of the few places where the odds are stacked in your favor of that being the case. There’s a lot to be said for initiating a position in Coca-Cola, and then relentlessly adding to it over the course of your lifetime. The profits go up just about every year—there have only been about four occurrences in the past eighty or so years when that has not been the case. The dividend has gone up every year for 50+ years running now. It’s such an obvious way to get rich. When you have the option to become the part owner of such an excellent enterprise, why not make it a priority in your own life? Life’s a lot more fun when you have a perpetual money-generating machine under your belt.
Originally posted 2014-01-24 08:26:42.