Why Dollar Cost Averaging Feels Safe but Leaves You Worse Off

Investors employ dollar cost averaging by dividing their cash into segments and converting each segment into stocks according to a predetermined schedule. Investors are more likely to increase their wealth with lump-sum investing than with dollar cost averaging, yet the practice persists. Why? This is the puzzle.
— Meir Statman

Behavioural finance professor Meir Statman is right that cost averaging usually ends up costing investors money. A study from Vanguard found it does so 68% of the time.

Why, then, is it the standard advice of financial advisors?

According to behavioural finance researcher Meir Statman, the explanation comes down to one word.

Fear.

"Investors want the high expected returns of stocks," Statman wrote, "but they also want to avoid the emotional costs of regret over losses."

Investors who are afraid of losses might simply avoid buying stocks altogether. This is the worst outcome of all because, most of the time, cash delivers worse returns than both lump-sum investing and cost averaging.

The value of dollar cost averaging is that it helps investors overcome their fear of loss and more quickly get their cash into higher-returning stocks.

Meir Statman is a Professor of Finance at Santa Clara University. His most recent book, A Wealth of Well-Being: A Holistic Approach to Behavioral Finance, gets 4.4 stars on Amazon.

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