Dollar Cost Averaging (DCA) — when combined with an Index Fund — provides a highly effective way of applying powerful Value Investing principles with very little effort.
Dollar Cost Averaging
A regular investment will result in more investment when a stock is underpriced, and reduced error when a stock is overpriced. This is the principle on which Dollar Cost Averaging works.
Warren Buffett's mentor, Benjamin Graham, writes:
"The third is the device of “dollar-cost averaging,” which means simply that the practitioner invests in common stocks the same number of dollars each month or each quarter. In this way he buys more shares when the market is low than when it is high, and he is likely to end up with a satisfactory overall price for all his holdings."
Warren Buffett is often quoted on multiple mainstream websites as having said:
“If you like spending 6-8 hours per week working on investments, do it. If you don’t, then dollar-cost average into index funds. This accomplishes diversification across assets and time, two very important things.”
However, there is no record of Buffett having said the above either on buffett.cnbc.com or berkshirehathaway.com; and this could be just another popular Value Investing misquote.
Fortunately, what Buffett actually said appears to be quite similar in meaning to the above.
“We never recommend buying or selling Berkshire. But I would say that, among the various propositions offered you, a very low-cost index fund where you don’t put all your money in at one time."
"I mean, if you accumulate a low-cost index fund over 10 years with fairly regular sums, I think you will probably do better than 90 percent of the people around you that take up investing at a similar time.”
Graham was one of the first to point out that actively managed funds don't keep up with the market indices.
"Taken as a whole, however, the all-common-stock funds failed over a long span of years to earn quite as good a return as was shown on Standard & Poor’s 500-stock averages or the market as a whole. This conclusion has been substantiated by several comprehensive studies."
He therefore gave the following recommendation on Investment Funds.
"If you want to put money in investment funds, buy a group of closed-end shares at a discount of, say, 10% to 15% from asset value, instead of paying a premium of about 9% above asset value for shares of an open-end company."
Graham also taught that the easiest investment strategy — for a regular investor — was to invest in stocks comprising an Index.
"This could be done, most simply perhaps, by buying the same amounts of all thirty of the issues in the Dow-Jones Industrial Average (DJIA)."
Since Index Funds did not exist in Graham's day, it should be safe to say that Graham's first recommended strategy today would have been to invest in a reputed Index Fund.
In his annual letters to shareholders as Chairman of Berkshire Hathaway Inc, Warren Buffett writes:
"By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb."
"My regular recommendation has been a low-cost S&P 500 index fund. To their credit, my friends who possess only modest means have usually followed my suggestion."
Combining Dollar Cost Averaging with an Index Fund therefore is a great way to get started with Value Investing, before graduating into more advanced strategies.
A Value Investing masterclass by Graham and dean Courtney Brown, at Columbia Business School (circa 1955).
The topics covered include the Efficient Market Hypothesis (EMH), investing on Margin, Inflation and Dollar Cost Averaging (DCA).
Buffett On CNBC
Buffett speaks to CNBC's Becky Quick in this 2018 interview, saying buying and holding Index Funds has worked.
Bogle About DCA
In this 2014 interview, John Clifton "Jack" Bogle — founder and former chief executive of The Vanguard Group — explains how Dollar Cost Averaging helps.