I have come across an interesting analysis conducted in the US by The Market Analysis, Research and Education (MARE) group, a unit of Fidelity Management & Research Company (FMRCo), which looked at four possible investor strategies:
The Stay-the-Course Investor - Maintains dollar-cost averaging throughout a bear market.
The Bear Market Dodger - Effectively avoids the bear market by shifting 100% of new contributions to cash before incurring any losses, and shifts 100% of new contributions back into stocks as the market resumes a long-term uptrend.
The Bear Market Refugee - Shifts all new contributions to cash at the onset of a bear market (20% drop), and shifts 100% of new contributions back into stocks as the market resumes a long-term uptrend.
The Doomsday Capitulator - Shifts 100% of new contributions to cash at the bear market's cyclical low point, and shifts 100% of new contributions back into stocks as the market resumes a long-term uptrend.
The analysis looks at the previous tough bear market in the US of 2000-02 where the S&P 500 fell by 47%.
The analysis assumed that each investor had a starting balance of $10,000 entirely invested in equities, and was making monthly contributions of $500 per month to stocks prior to the arrival of a bear market. These investment parameters reflect the situation of an investor using dollar-cost averaging to accumulate wealth or save for a long term goal.
For the three market-timing investor scenarios that chose to shift their future contributions to cash (Bear Market Dodger, Bear Market Refugee and Doomsday Capitulator), MARE chose a common date on which all three investors resumed their contributions back to stocks: January 2004. This date was chosen based on historical analysis on how long it typically takes investors to feel comfortable buying stocks again after a bear market.
The results were:
This analysis shows the benefit of implementing a dollar cost averaging strategy. By buying more shares at lower prices throughout the equity market downturn, the Stay-the-Course Investor was able to reap bigger portfolio gains when the market recovered.
Care needs to be taken in anlysing these results as they are taken from one particular time period and have some underlying assumptions that may be questioned by readers - e.g. What if the bear market dodgers returned to the market earlier than January 2004?
That being said, it does provide some further anecdotal evidence supporting the use of a dollar cost averaging strategy. This is the strategy being employed by nearly everyone who is making regular contributions to superannuation. Since June 2007, our firm has been suggesting this strategy for any clients coming to us with new money or new clients coming with cash.
This approach does not appeal to those with market timing instincts, but as academic and scientific research continues to show us, market timing rarely provides stronger levels of performance over the long term.
If you would like to read the full article discussing the study conducted by MARE please go to the article: Dollar-cost averaging: The bear market solution investment strategy