Mar 1, 2009
Why DCA for Stocks is a Bad Idea
A popular investing technique for those who don’t have the time or energy to research the day to day market is dollar cost averaging, or DCA. The idea behind dollar cost averaging is a simple one: always invest a fixed dollar amount in at a fixed frequency, regardless of the stock price. Thus, when the stock price is high you purchase less shares, and when the stock price is low, you purchase more shares. I think DCA is a great idea for no load mutual funds, but a terrible idea for individual stocks. Let’s look at why:
- Most mutual fund providers like Vanguard
don’t charge transaction fees or commissions to buy mutual funds. But almost all stock brokerage firms do.
- Let’s say you invest in a company at $100 per week. Even a modest commission of $4 a transaction results in an immediate 4% loss on your investment, before the stock has even done anything!
- Even if you’re willing to take the commissions hit, do you really want to put all your eggs in one basket? Even traditional, stable companies like Wachovia have catastrophically collapsed on itself. American staples like GM and Ford are no longer sure bets as well.
Since the transaction fee is fixed, dollar-cost averaging can only work with a large dollar amount. Unfortunately, the whole reason people invest small amounts at a time is because they don’t have money in the first place! Thus, my suggestion is avoid companies that promote automatic investment in the stock market, such as MyStockFund — you’re far better off in the long run with a good set of mutual funds.