Monday, January 24, 2011

Dollar Cost Averaging in Ugly Markets

Pragmatic Capital’s summary of Jeff Saut’s weekly commentary reminded of my dollar-cost averaging notion that I had on (I’m not kidding) March 9, 2009 in an email:

“Another thought I had:

What if you started investing 10%/month in Dow  for 10 months until 100% equity allocation  after you hit the 60% drawdown level in September 1931?  These are your returns pursuing such a strategy.  Good to know assuming this is the absolute worst case  (can't think of much worse than the Great Depression with 89% ultimate drawdown) .  I like my chances.”

The thought at that point was how can we overcome the panic/despair/despondency of the dreadful market in 2008 and take definitive action to transform ugliness into opportunity.  So, knowing in 2008, that the bottom was unknowable, I thought I could test dollar cost averaging on the worst market in US history and see how it might work.  I picked without optimization 60% as the drawdown level to initiate a 10 month (makes the math easier) 10%/month allocation to the Dow Jones (1929-1931) and S&P500 (2007-2008).  The 60% drawdown level on monthly average basis hit September 1931, so let’s see how it worked then.  Just knowing the worst case can help overcome the disabling fear.  A little tweaking would dramatically improve the performance, but I wanted to be intellectually honest and not optimize.


Unfortunately for the system but fortunately for the remaining equity investors, the S&P 500 did not hit 60% drawdown in the 2008 crisis.  Just for fun, let’s tie this post and system concept to the caution of my “Perils of Bottom Picking” post by amending the drawdown to 55% and only investing when the index moves up on a monthly basis in tomorrow’s post (have not done, so will be a surprise to me too)…

75 minutes

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