Reacting to Price Drops during DCA: 50%

I examined what happens to a 100% stock investor after a 50% loss over two years. I assumed that he dollar cost averages. I assumed that he would cut his holdings to 50% stocks after such a blow.

Scenario Surfer Runs

I started out with 100% stocks. I cut back to 50% stocks whenever I suffered a 50% loss over two years. I invested entirely in stocks and 2% TIPS. I started with a $1000 balance. I selected P/E10=26 Bear Market. I deposited $1000 (plus inflation) each year. Here are the Year 30 balances. I did not vary allocations in accordance with valuations.

Run 1.
Year of Loss: never.
20% rebalanced: 52,725.
50% rebalanced: 69,692.
80% rebalanced: 89,781.
100% Stocks initially: 104,700.

Run 2.
Year of Loss: never (early drop, but small balance).
20% rebalanced: 71,002.
50% rebalanced: 140,290.
80% rebalanced: 255,325.
100% Stocks initially: 363,718.

Run 3.
Year of Loss: never (early drop, but small balance).
20% rebalanced: 58,822.
50% rebalanced: 90,720.
80% rebalanced: 133,949.
100% Stocks initially: 169,165.

Run 4.
Year of Loss: never.
20% rebalanced: 56,865.
50% rebalanced: 84,255.
80% rebalanced: 121,391.
100% Stocks initially: 152,257.

Run 5.
Year of Loss: never.
20% rebalanced: 53,726.
50% rebalanced: 72,370.
80% rebalanced: 93,355.
100% Stocks initially: 107,788.

Data Summary

Here are the ordered Year 30 balances:

363,718.
169,165.
152,257.
107,788.
104,700.

Analysis

Not once was the 50% price drop threshold met. There were two out of five instances of a sharp price drop early. New money from dollar cost averaging prevented the balance from falling dramatically.

Conclusion

A dollar cost averaging investor is likely to stick with a 100% stock allocation in today�s market because the bad years are likely to occur early.

Have fun.

John Walter Russell
June 3, 2008