Building a Better Mousetrap: Enhanced Dollar-Cost Averaging

Abstract

This article presents a simple, intuitive investment strategy that improves upon the popular dollar-cost-averaging (DCA) approach. The investment strategy, called enhanced dollarcost-averaging (EDCA), is a simple, rule-based strategy that retains most of the attributes of traditional DCA that are appealing to most investors yet adjusts to new information, which traditional DCA does not. Simulation results show that the EDCA strategy reliably outperforms the DCA strategy in terms of higher dollar-weighted returns about 90% of the time and nearly always delivers greater terminal wealth for reasonable values of the risk premium. EDCA is most effective when applied to high-volatility assets, when cash flows are highly sensitive to past returns, and during secular bear markets. Historical back-testing on equity indexes and mutual funds indicates that investor dollar-weighted returns can be enhanced by between 30 and 70 basis points a year simply by switching from DCA to EDCA.

TOPICS: Portfolio construction, mutual funds/passive investing/indexing, performance measurement