pug said:
I appreciate what you're saying. Could you clarify a bit further on this. Where I find DCA has helped me as an investor in the past is because when I invest I never fully know 100% where the market is going to be going forward. Sometimes I invest and it goes down and it's a good thing I didn't put 100% in at that time. From what you're saying, you'd do better assuming the market only goes up from where you went all in. Or is there more to this?
@pug:
Psychologically DCA has huge appeal, no matter what happens tomorrow, you can convince yourself that what you did today was the right move. If silver declines between now and tomorrow, or between now and next month, you can consider yourself lucky you didn't put all your money in because now you can buy it at an even cheaper price. On the flip side, if the market goes up, and you have to buy tomorrow at a more expensive price, you can turn this around and think you are lucky because at least you bought some yesterday. You will be happy regardless.
As far as risk is concerned, DCA has no advantage it merely defers risk to a later time. It does, however, lower expected volatility - another phsycological benefit. Even if you use DCA to buy silver over a year or two, at some point you are going to have half of your money in silver, which would make you vulnerable to losing a chunk of it. If you are willing to take that risk in a couple of years, you should be willing to do so today. If not, do you really consider silver a good investment at all? Should you risk any money? Maybe you should lower your allocation to an amount more comfortable or affordable?
Conversely, if you consider silver a good investment, then what is the risk that price takes off while a chunk of your cash is on the sideline? Given you are bullish on silver, taking this risk of opportunity-loss does not make sense? And can actually cost you more.
Now, a simple example of the mathematics:
Let's say that you get a $10,000 windfall. Based on silver's average gains in the past, you figure it's reasonable to expect a one-year return of about 12.5% (about average for silver over the past few decades), which would leave you with $11,250. But you also know that silver is volatile. In fact, it has an annual standard deviation of about 30 percentage points, which means that roughly two-thirds of the time silver will return somewhere between 30 percentage points above (42.5%) or below (negative 17.5%) it's average yearly return. So while you hope to have $11,250 after year 1, there's a good chance you'll end up with as little $8,250 or as much as $14,250, a difference of $3,000 in both directions.
To avoid that worst-case scenario, you decide to dollar-cost average. Let's assume you put your ten large into a bank account that has zero volatility and pays 5% annually and you then gradually move the money into silver over the course of a year. Based on the historical returns, you can expect to have $10,871 at the end of one year. And based on the lower standard deviation (because of the cash), you expect only a $1,681 swing in either direction. So you've given up $379 in expected return ($11,250 minus $10,871), but you've lowered volatility by a lot more, $1319 ($3,000 minus 1,681).
This doesn't mean that there's no situation in which you couldn't come out ahead by dollar-cost averaging. Each strategy wins at least some of the time, but DCA is the statistical "dog", losing about two times out of three. Of course, dollar cost averaging will win if your start date falls right before a dramatic crash or at the start of an overall 12 month slump. But unless you can predict these downturns ahead of time, you have no scientific reason to believe that dollar cost averaging will give you an advantage. So we've got to make the best decisions we can based on probabilities. And those probabilities say that dollar-cost averaging isn't a good way to balance risk and reward.
