One of the big questions that savers who want to invest in the stock market have is what is the best way to proceed to obtain the best results Should we be putting money month by month or is it a better alternative to save and later when there is a fall to invest everything saved up to that moment?
Today we resolve this doubt of both long-term investment strategies. But before we begin, we must describe them.
The first alternative tends to be known by dollar cost average (DCA) what part of the idea of invest a fixed amount periodically in the stock marketregardless of whether the market goes up or down.
Buy in falls
Buying in drops translates to periodically saving a certain amount in cash until the market falls below a certain percentage amount from its all-time highs.
Once the market drops enough, a certain percentage from highs, all the cash saved is invested. From there, we periodically invest until the market hits all-time highs. At that time, starting over, we accumulate cash again until the next drop in it occurs in percentage terms than the previous one.
This tends to be the most used strategy. Just as we buy any item when it is on sale, the same happens with buying from the market when it is down.
We will take the study by Nicolás Maggiulli published in Of dollars and data which runs as follows:
With DCA we invest $ 100 each month for 20 years. In contrast, with the wait-for-dips methodology, we save $ 100 per month until the market falls and all of the saved cash is invested and continues to invest $ 100 each month until the market reaches another all-time high. At that point, cash is accumulated again until the next drop of the same size occurs. And so on throughout the 20-year period.
The results observed in all the 20-year periods from 1920 to 2020 is that the average profitability of using the strategy of buying on falls for 20 years ranges between -5% and -13% compared to the DCA, depending on the drop threshold to be used.
It is unlikely that If we rely on waiting for small falls to enter the market, we will win over the DCA in the long term vs. whether we expect big drops between 1920 and 2020: When using a strategy of entering a 10% to 20% drop threshold, there is a one in four chance of defeating the DCA.
DCA is better strategy
If we use a threshold of 50%, the probability of exceeding the DCA increases to almost four out of ten. But this comes at a price because, while you are more likely to exceed the DCA when you use a higher decline threshold, your final profitability will decline more (on average).
This happens because the strategy of waiting for dips to enter, tends to stay in cash too long. Since these monies are not capitalized in the investment, they do not take advantage of the full potential of the long-term interest force of the market.