When Price Drops Occur (DCA and VII variant 2A)

I made an additional 5 runs of DCA and VII variant 2.

In that variant, I dollar cost averaged (DCA) while varying my stock allocation. I invested 80% in TIPS and 20% in stocks until P/E10 fell below 15. Then I applied Valuation Informed Indexing.

Scenario Surfer Runs

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 varied allocations in accordance with valuations as measured by P/E10. P/E10 values are in “Current Years” in the “Portfolio Allocation” box.

Run 1.
P/E10 below 20 in Year 9.
P/E10 below 15 in Year 11.
P/E10 below 10 in Year 13.
20% rebalanced: 54,099.
50% rebalanced: 72,522.
80% rebalanced: 91,816.
DCA VII 2A: 138,132.

Run 2.
P/E10 below 20 in Year 7.
P/E10 below 15 in Year 9.
P/E10 below 10 in Year 12.
20% rebalanced: 62,446.
50% rebalanced: 105,027.
80% rebalanced: 168,207.
DCA VII 2A: 121,012.

Run 3.
P/E10 below 20 in Year 6.
P/E10 below 15 in Year 8.
P/E10 below 10 in Year 25.
20% rebalanced: 53,679.
50% rebalanced: 71,181.
80% rebalanced: 90,080.
DCA VII 2A: 105,122.

Run 4.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 5.
P/E10 below 10 in Year 6.
20% rebalanced: 54,478.
50% rebalanced: 75,942.
80% rebalanced: 103,431.
DCA VII 2A: 136,449.

Run 5.
P/E10 below 20 in Year 12.
P/E10 below 15 in Year 13.
P/E10 below 10 never.
20% rebalanced: 51,814.
50% rebalanced: 66,098.
80% rebalanced: 81,278.
DCA VII 2A: 81,201.

TIPS only baseline:
Zero % stocks: 43,191.

Data Summary

Here are the balances ordered in terms of when P/E10 first falls below 20:

P/E10 below 20 in Year 4: balance 136,449.
P/E10 below 20 in Year 6: balance 105,122.
P/E10 below 20 in Year 7: balance 121,012.
P/E10 below 20 in Year 9: balance 138,132.
P/E10 below 20 in Year 12: balance 81,201.

Here are the balances ordered in terms of when P/E10 first falls below 15:

P/E10 below 15 in Year 5: balance 136,449.
P/E10 below 15 in Year 8: balance 105,122.
P/E10 below 15 in Year 9: balance 121,012.
P/E10 below 15 in Year 11: balance 138,132.
P/E10 below 15 in Year 13: balance 81,201.

P/E10 below 10 in Year 6: balance 136,449.
P/E10 below 10 in Year 12: balance 121,012.
P/E10 below 10 in Year 13: balance 138,132.
P/E10 below 10 in Year 25: balance 105,122.
P/E10 below 10 never: balance 81,201.

Here are the P/E10 thresholds versus the ordered Year 30 balances:

138,132 and years 9, 11 and 13.
136,449 and years 4, 5 and 6.
121,012 and years 7, 9 and 12.
105,122 and years 6, 8 and 25.
81,201 and years 2, 13 and never.

Data Analysis

In all instances, owning stocks proved beneficial.

In all instances, an 80% stock allocation was best among fixed allocations. Higher allocations were better than lower fixed allocations.

Varying allocations produced the largest final balance in 3 out of 5 instances.

This algorithm seems to be mildly sensitive as to when prices fall below P/E10=10, but not when P/E10=20 and P/E10=15. If so, the sensitivity is weak.

This algorithm is similar to using Valuation Informed Indexing throughout.

This algorithm is a little bit better than the original variant, which started with 0% stocks. It is a whole lot better in terms of human emotions. It reduces regret if stocks rise in the early years.

Conclusions

This two stage dollar cost averaging algorithm is roughly the same as using Valuation Informed Indexing throughout. It is better than the earlier variant which started out with no stocks at all.

Have fun.

John Walter Russell
May 21, 2008