When Price Drops Occur (DCA and VII variant)

I dollar cost averaged (DCA) while varying my stock allocation. I invested entirely in TIPS until P/E10 fell below 15. Then I applied Valuation Informed Indexing.

This version is almost as good as using Valuation Informed Indexing throughout.

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 5.
P/E10 below 15 in Year 6.
P/E10 below 10 in Year 9.
20% rebalanced: 52,687.
50% rebalanced: 66,836.
80% rebalanced: 78,075.
DCA VII A: 152,957.

Run 2.
P/E10 below 20 in Year 9.
P/E10 below 15 in Year 12.
P/E10 below 10 never.
20% rebalanced: 48,997.
50% rebalanced: 57,748.
80% rebalanced: 66,026.
DCA VII A: 88,290.

Run 3.
P/E10 below 20 in Year 3.
P/E10 below 15 in Year 9.
P/E10 below 10 in Year 16.
20% rebalanced: 53,369.
50% rebalanced: 70,400.
80% rebalanced: 88,285.
DCA VII A: 127,653.

Run 4.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 10.
P/E10 below 10 never.
20% rebalanced: 47,311.
50% rebalanced: 51,973.
80% rebalanced: 53,741.
DCA VII A: 69,097.

Run 5.
P/E10 below 20 in Year 5.
P/E10 below 15 in Year 6.
P/E10 below 10 in Year 8.
20% rebalanced: 54,141.
50% rebalanced: 73,842.
80% rebalanced: 96,786.
DCA VII A: 123,697.

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 3: balance 127,653.
P/E10 below 20 in Year 4: balance 69,097.
P/E10 below 20 in Year 5: balances 152,957, 123,697.
P/E10 below 20 in Year 9: balance 88,290.

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

P/E10 below 15 in Year 6: balances 152,957, 123,697.
P/E10 below 15 in Year 9: balance 127,653.
P/E10 below 15 in Year 10: balance 69,097.
P/E10 below 15 in Year 12: balance 88,290.

Here are the balances ordered in terms of when P/E10 first falls below 10:

P/E10 below 10 in Year8: balance 123,697.
P/E10 below 10 in Year 9: balance 152,957.
P/E10 below 10 in Year 16: balance 127,653.
P/E10 below 10 never: balances 88,290, 69,097.

Here are the P/E10 thresholds versus the ordered Year 30 balances:
152,957 years 5, 6 and 9.
127,653 and years 3, 9 and 16.
123,697 and years 5, 6 and 8.
88,290 and years 9, 12 and never.
69,097 and years 4, 10 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 5 out of 5 instances.

This algorithm is sensitive as to when prices fall below both P/E10=15 and P/E10=10. It is not sensitive as to when P/E10 falls below 20.

This algorithm is similar to using Valuation Informed Indexing throughout. However, it has a wider spread. Regular Valuation Informed Indexing does a better job of lifting the lowest balances.

Conclusions

This two stage dollar cost averaging algorithm is almost as good as using Valuation Informed Indexing throughout.

This dollar cost averaging algorithm is sensitive as to when price drops occur. The sooner, the better. The deeper, the better.

Have fun.

John Walter Russell
May 20, 2008