runewell
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Post by runewell on Feb 10, 2011 17:05:10 GMT -5
From the criticism section of Wikipedia's entry on Dollar Cost Averaging: While some financial advisors such as Suze Orman [5] claim that DCA reduces exposure to certain forms of financial risk associated with making a single large purchase, others such as Timothy Middleton claim DCA is nothing more than a marketing gimmick and not a sound investment strategy.[6] Middleton claims that DCA is a way to gradually ease worried investors into a market, investing more over time than they might otherwise be willing to do all at once. Others supporting the strategy suggest the aim of DCA is to invest a set amount; the same amount you would have had you invested a lump sum.[7] Analysis supporting dollar cost averaging has been criticized because it often ignores transaction fees,[dubious – discuss] which can be substantial. Numerous[citation needed] studies of real market performance, models, and theoretical analysis of the strategy have shown that in addition to having the admitted lower overall returns, DCA does not meaningfully reduce risk when compared to other strategies, including a completely random investment strategy.[8] Discuss
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hoops902
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Post by hoops902 on Feb 10, 2011 17:11:45 GMT -5
Analysis supporting dollar cost averaging has been criticized because it often ignores transaction fees,[dubious – discuss] which can be substantial. Numerous[citation needed] studies of real market performance, models, and theoretical analysis of the strategy have shown that in addition to having the admitted lower overall returns, DCA does not meaningfully reduce risk when compared to other strategies, including a completely random investment strategy.[8] Discuss I'm going to focus on 2 things. 1. Yes it's going to trend toward lower overall returns since the idea is that you are investing pieces through a market which overall has trended upward. 2. I'm not sure what you mean by a "completely random investment strategy". I assume you mean investing at completely random times? If so, then yes, it wouldn't reduce risk that much because you're still essentially doing what dollar cost averaging aims to do, namely to invest you at different intervals so as not to lock you into the pricing risk at one point in time. The comparison should not be with a completely random investment strategy, but with an investment strategy of investing the entirety of what you would invest with DCA at a singular point in time. You could set up a random number generator and have it invest $100,000 for you at random over a year and compare that to a bi-weekly DCA investment for the year and I wouldn't be surprised to see minimal risk reduction in the DCA. But since no one invests in a completely random way, the comparison (again, assuming it actually means completely random) isn't very useful since completely random investment isn't going to be the realistic alternative to DCA.
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Post by Savoir Faire-Demogague in NJ on Feb 10, 2011 17:13:03 GMT -5
Analysis supporting dollar cost averaging has been criticized because it often ignores transaction fees,[dubious – discuss] which can be substantial. Numerous[citation needed] studies of real market performance, models, and theoretical analysis of the strategy have shown that in addition to having the admitted lower overall returns, DCA does not meaningfully reduce risk when compared to other strategies, including a completely random investment strategy.[8]
DCAing is a good way for the middle class schmo who does is not executing routine $250,000 buy/sell orders every month.
For the most part, the average wage earning person's primary investment vehicle is their defined contribution plan at work. DCAing is really the only way to go. Yeah, most of us also have taxable accounts that we toss in a few thousand every now and then.
Take one's contributions to the IRA. You may not have the $5000 or $6000(if over 50), at the beginning of the year. The only way to contribute is to put money in when you have it.
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hoops902
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Post by hoops902 on Feb 10, 2011 17:16:56 GMT -5
"Take one's contributions to the IRA. You may not have the $5000 or $6000(if over 50), at the beginning of the year. The only way to contribute is to put money in when you have it."
+1
Also, the calculations for "returns" via either DCA'ing into the market or investing in one lump sum generally work on the assumption that if you invested the lump sum that you would invest it right now rather than at the end of the year. Practically speaking for working stiffs they wouldn't be able to invest the lump sum until they had saved all year to get it. Financially speaking the comparison to DCA vs Lump Sum generally assume investment of Lump Sum at t=0 rather than t=1 which is likely not true for the majority of the population.
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Deleted
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Post by Deleted on Feb 10, 2011 18:38:46 GMT -5
I read somewhere (several years ago) that the returns are pretty much equal. But if you have a lump sum, as I did when I got a divorce, it IS pretty worrisome to $100,000 into the market on one given day.
Most 401ks are a form of dollar cost averaging.
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Post by Savoir Faire-Demogague in NJ on Feb 11, 2011 7:13:24 GMT -5
I read somewhere (several years ago) that the returns are pretty much equal. But if you have a lump sum, as I did when I got a divorce, it IS pretty worrisome to $100,000 into the market on one given day.
The thing about investment returns, is more about being IN the market and diversified. I have some analysis of decades and decades of market pricing data, which show that if one was not in the market on just a handful of days in each year the loss of annual return is significant. I'd have to dig this up. I do agree placing a large sum all at once can be pretty daunting.
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Post by Deleted on Feb 11, 2011 9:41:13 GMT -5
I have some analysis of decades and decades of market pricing data, which show that if one was not in the market on just a handful of days in each year the loss of annual return is significant. I'd have to dig this up. Conversely, if you're able to stay completely out of the market for a few select days days each year, you could also significantly increase your overall returns. Good luck picking those handful of days.
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sunuva
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Post by sunuva on Feb 11, 2011 10:02:26 GMT -5
Dollar Cost Averaging is just averaging down. It's the lazy man's method for saying "I don't want to bother with my investments so I am willing to just give someone else a pocket of money on a regular basis to throw it into a fund of a bunch of stuff."
It's not so hard to have a fund determined for you with your risk profile. Now that the fund (or funds) are identified it isn't so hard to see what, exactly, makes up those funds. With that information, I'd cherry-pick the best out of that fund. If that seems too daunting, well then, you are in the realm of "I don't want to bother with my investments."
Heck, funds that have a "financial" component within them probably have a smattering of all of the financials available - so they aren't picking and choosing specific banks, for example, they are picking all of the banks - they are picking the sector. Follow that through with everything they have any you aren't necessarily picking the best in any particular sector but rather having a smattering of everything in the sectors and banking on more players getting it right than wrong.
At least if you are going to do the DCA have the wherewithall to open your own discount brokerage account and get minimal transaction fees. Heck, with enough trades in a given period of time you may not have any fees at all. If you don't do that, you may realize that dropping $2000 every month as a DCA may also generating $20 (or more) in transaction fees just for executing the trade. That's one-percent right there (or more) that you can easily address and improve your returns. If the strategy is "not the best but just a little bit better than before, then at least get your little bit more than before by keeping an extra one-percent that you otherwise would not have.
But that should mesh with your risk profile. If your risk profile is high - why would you even want to DCA - there's no risk in that - it's counter to your profile?
But this is just one man's opinion - based on my own investing history stretching back to 1992 with my very first dollar invested (into a DCA scheme) - and I feel 18 years is plenty of time for me to formulate my own strategy and risk profile and involvement - others may not feel as I do.
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Post by Savoir Faire-Demogague in NJ on Feb 11, 2011 10:11:30 GMT -5
Conversely, if you're able to stay completely out of the market for a few select days days each year, you could also significantly increase your overall returns. Good luck picking those handful of days.
Yes, which supports the analysis I have laying around somewhere. One should always be fully invested, and fully diversified in all segments of the markets. I'll have to find that data, but if I recall it was Ibbotson that did the analysis which was on something like 80 years of market data. If I remember I will look for it tonight.
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Post by Savoir Faire-Demogague in NJ on Feb 11, 2011 10:15:17 GMT -5
Dollar Cost Averaging is just averaging down. It's the lazy man's method for saying "I don't want to bother with my investments so I am willing to just give someone else a pocket of money on a regular basis to throw it into a fund of a bunch of stuff."
The largest players in the financial markets invest this way.
Incidentally, the lazy man, as you put it, does not have $500,000 at their disposal. The best they can do is DCA via their monthly paychecks into their 401K plans. I am actively involved in reviewing my 401K allocations continuously and re-balancing as necessary. I do realize the bulk of the population is clueless, but many are not.
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Post by ca on Feb 11, 2011 10:18:03 GMT -5
If we believe the market is going to go up over time, rather than down, it makes sense to invest as early as possible; rather than incrementally, from a strictly logical standpoint.
This assumes you have a lump sum to invest now.
Investing every time you get paid through a 401k at work is not Dollar Cost Averaging, it's just saving and investing a lump sum every time you get paid.
Example - If you had an inheritance and got $50,000 and decided to invest that $50,000 over the next year every 2 weeks in $2,000 increments, that would be dollar cost averaging.
My thinking is you'd be better off if the market goes generally up over the year by putting that $50,000 in when you get it rather than in increments. Of course if it goes down over the year, you'd have lost less money by dollar cost averaging. But if you expect it to go down, why are you putting it in the market in the first place?
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Post by Savoir Faire-Demogague in NJ on Feb 11, 2011 10:22:09 GMT -5
Investing every time you get paid through a 401k at work is not Dollar Cost Averaging, it's just saving and investing a lump sum every time you get paid.
I put $22,000 annually into my 401K plan. It is taken out of each pay check($22,000/24) and it comes to $916 twice per month. One day later these funds, along with company match are deposited into the plan. That seems to me, to be what the definition of dollar cost averaging.
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hoops902
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Post by hoops902 on Feb 11, 2011 10:22:56 GMT -5
"But that should mesh with your risk profile. If your risk profile is high - why would you even want to DCA - there's no risk in that - it's counter to your profile?"
It's not counter to your profile if the reason you are DCA'ing into the market is that it's concurrent with when you have the funds to invest.
"At least if you are going to do the DCA have the wherewithall to open your own discount brokerage account and get minimal transaction fees. Heck, with enough trades in a given period of time you may not have any fees at all. If you don't do that, you may realize that dropping $2000 every month as a DCA may also generating $20 (or more) in transaction fees just for executing the trade. That's one-percent right there (or more) that you can easily address and improve your returns. If the strategy is "not the best but just a little bit better than before, then at least get your little bit more than before by keeping an extra one-percent that you otherwise would not have."
While I agree with the idea of trying to lower transaction costs, it would be worth 1% to me to be able to DCA funds in throughout the year as I am paid rather than trying to save up all year to invest it all at the end when I've missed out on an average of 6 months of being in the market.
I think a lot of your analysis is correct with regard to people being lazy, that isn't necessarily anything to do with DCA though. DCA is simply the timing of when you put your money into the market. You can be just as prudent about what you are investing in with DCA as you can be ignorant about what you're investing in with a one-time lump sum investment.
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Post by ca on Feb 11, 2011 10:37:52 GMT -5
No, that's saving a portion of your income everytime you get paid.
Dollar Cost Averaging would be taking existing money and rather than investing it all at once, spreading that money out and investing it over a period of time.
If you had $22,000 on January 1st, then decided to invest every 2 weeks, that is dollar cost averaging. Investing $916 everytime you get paid works out to the same thing as that, but strictly speaking, its not if it's coming out of money you earned during the year. It's just investing a lump sum in the market when you earn it.
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hoops902
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Post by hoops902 on Feb 11, 2011 10:40:12 GMT -5
No, that's saving a portion of your income everytime you get paid. Dollar Cost Averaging would be taking existing money and rather than investing it all at once, spreading that money out and investing it over a period of time. If you had $22,000 on January 1st, then decided to invest every 2 weeks, that is dollar cost averaging. Investing $916 everytime you get paid works out to the same thing as that, but strictly speaking, its not if it's coming out of money you earned during the year. It's just investing a lump sum in the market when you earn it. No, actually dollar cost averaging is simply purchasing a fixed dollar amount of securities at regular intervals. It's DCA whether you start out with a lump sum or invest it as you get it, as long as it's a fixed amount at regular intervals, it's DCA.
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schildi
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Post by schildi on Feb 11, 2011 10:45:10 GMT -5
Investing every time you get paid through a 401k at work is not Dollar Cost Averaging, it's just saving and investing a lump sum every time you get paid. I put $22,000 annually into my 401K plan. It is taken out of each pay check($22,000/24) and it comes to $916 twice per month. One day later these funds, along with company match are deposited into the plan. That seems to me, to be what the definition of dollar cost averaging. I would agree, Savior. CA has a point, too, though. What he is saying (if I understand correctly) is that it's not DCA'ing if you don't have the lump sum at the beginning, meaning you don't have the option of lump sum investing. Because in that case it is somewhat useless to discuss DCA'ing vs. lump sum investing, unless it means saving up the balance ($22K in your example) and investing it at the END. And that would turn the calculations around, and is not what is being analyzed. Well, I guess it's really how you look at it.
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hoops902
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Post by hoops902 on Feb 11, 2011 10:52:10 GMT -5
"And that would turn the calculations around, and is not what is being analyzed."
Agree, and that's the problem, that when DCA is being analyzed to show that it's not as good as reported, it's being analyzed in the way that it's less commonly used as opposed to the way it's more commonly used...both of which are in the exact definition of what DCA is.
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runewell
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Post by runewell on Feb 11, 2011 10:53:18 GMT -5
Later in the article, wikipedia says this:
Having money taken out of your paycheck is automatic investing, NOT dollar cost averaging.
Oh and is Dollar cost averaging akin to market timing? Long-term the trend is up. If you aren't all-in, are you then expecting the market to drop?
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Post by ca on Feb 11, 2011 11:16:07 GMT -5
Yep.
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schildi
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Post by schildi on Feb 11, 2011 11:31:49 GMT -5
Makes sense to me. Unless you now take the lump sum you had laying around and did not want to invest as lump sum and use it for your everyday expenses, instead of the paycheck that is being invested over time. ;D Then we are back to dollar cost averaging.
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hoops902
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Post by hoops902 on Feb 11, 2011 11:46:43 GMT -5
"Having money taken out of your paycheck is automatic investing, NOT dollar cost averaging."
Whether a process is manual or automatic has nothing to do with whether it is dollar cost averaging or not.
"Discussions of the problems with DCA can do a disservice to investors who confuse DCA with continuous, automatic investing... "
IMO the disservice is done when people don't understand that there are multiple forms of dollar cost averaging and choose to focus on the less common version while pretending that the more common version is "something else".
From the same wikipedia page the definition of DCA: It takes the form of investing equal monetary amounts regularly and periodically over specific time periods (such as $100 monthly) in a particular investment or portfolio.
That's pretty much a dead on definition, pretending that something is not DCA simply because people want to refer to a segment of DCA and pretend it encompasses the whole of DCA is what leads to false information on the advantages/disadvantages of DCA.
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runewell
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Post by runewell on Feb 11, 2011 11:50:31 GMT -5
Dollar cost averaging is a choice to invest money of periods of time rather than all at one. I don't really have that choice with my paycheck. If I could opt to have all my 401k deposits for the entire year put in earlier, I would. But I can't.
I'm not choosing to DCA; I am simply investing all the money I can as soon as I can get my hands on it, which is the opposite of DCA.
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hoops902
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Post by hoops902 on Feb 11, 2011 12:16:53 GMT -5
Are you investing the same fixed amount at regular intervals? I fully agree that your 401k deposits MIGHT not be DCA, you might have variable pay and a percentage going into your 401k so that the amount differs each time and would not be DCA. You might also be switching up what you're investing in with each paycheck, investing in Stock A this month, Fund Q next month, Stock F, G, and H the month after...that also wouldn't be DCA.
DCA isn't dependent on having chosen to do it, it's dependent on a simple definition. You might want to DCA and be forced into investing a lump sum. You might want to invest a lump sum but are forced to take a DCA approach.
Not all automatic investing is DCA, that doesn't change the fact that some of it is.
"I'm not choosing to DCA; I am simply investing all the money I can as soon as I can get my hands on it, which is the opposite of DCA. "
In many cases I'm taking the same approach and I agree, that's not DCA'ing because "all the money I can get my hands on" isn't the same fixed amount in regular intervals. For example, I DCA into my 401k with a fixed investment twice per month into the same investments, outside of my 401k I invest random amounts into different investments at random times because I'm relatively young and want to get as much of my spare money into the market as possible. I agree that's the opposite of DCA, because it's neither a fixed amount, regular intervals, or necessarily into the same investments. That doesn't change the fact that my investment through my 401k which is all of those things is DCA simply because it gets done automatically.
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Post by ca on Feb 11, 2011 12:17:40 GMT -5
Dollar cost averaging refers to buying an investment, usually a stock or stock fund, over time in installments of equal dollar value. It is often confused with the laudable and similar idea of regularly saving. Setting aside a certain amount of your pay every week or month may look like dollar cost averaging, but it’s not exactly the same thing. Implicit in the question "is dollar cost averaging a good idea" is the premise that there is an alternative, that you could have invested it all at once rather than slowly as you earned it. In its purest form, the question of the wisdom of dollar cost averaging boils down to the following hypothetical. Imagine you have $12,000 you wish to invest in the stock market. Do you put it all in now or do you put in $1,000 a month for 12 months? Assuming that your goal is to maximize your expected return (a fairly safe assumption) and that having that $12,000 in the market is the right thing for you to do (more of a leap, but it’s a premise of the question) then you should put all the money in the market now. Dribbling it out over the next year will only reduce your returns if the market has a tendency to go up, and if it didn’t have a tendency to go up, why would you want to invest in it at all? Put another way, the dollar cost averaging choice is between buying at today’s price and buying at the average price over the next year. If you think the market is more likely to go up than down, you must also believe that today’s price is more likely to be lower than the average price over the next year. This isn’t really all that subtle or complicated. And yet dollar cost averaging enjoys widespread popularity. Partly, this may be confusion with the wholesome idea of sticking with a regular savings plan, something which deserves to enjoy widespread popularity. badmoneyadvice.com/2010/10/why-dollar-cost-averaging-is-popular-2.html#more-1239
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Post by ca on Feb 11, 2011 12:22:08 GMT -5
That post I just made is from the link in it, sorry I don't want to take credit for Frank's excellent writing!
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hoops902
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Post by hoops902 on Feb 11, 2011 12:51:43 GMT -5
"Setting aside a certain amount of your pay every week or month may look like dollar cost averaging, but it’s not exactly the same thing."
I agree, it's not exactly the same thing as the decision the author talks about, but that's because there are different ways to DCA, not because it's not DCA. I don't argue with the idea that having $12K to invest and choosing to spread out that investment or not having the $12K to begin with but having $1K per month to invest regularly are not the same decisions, I'm just arguing that both are DCA in differing forms.
My issue is that both are actually DCA, and saying "DCA doesn't make sense" fails to account for the fact the author isn't really arguing that, he's arguing that "this one portion of what DCA is doesn't make sense to me".
"Dribbling it out over the next year will only reduce your returns if the market has a tendency to go up, and if it didn’t have a tendency to go up, why would you want to invest in it at all?"
This is ignoring the idea of variance. Markets which go up do not go in a straight line, nor do they go down in a straight line. That said, I wouldn't DCA a lump sum right now, I want a little extra risk...the fact that I agree with the end recommendation doesn't mean I agree with his thought process to get there. Particularly the next point:
"Assuming that your goal is to maximize your expected return (a fairly safe assumption)"
This is not only NOT a fairly safe assumption, it's a terrible assumption. If I give you a guaranteed return of 20% per year, or a 1% chance of a 3,000% return and a 99% chance that you will lose every cent...most of us would take the 20% per year even though the expected return in scenario 1 is 20% and the expected return in scenario 2 is 30%. Almost none of us want to maximize our expected returns. I don't know the author's background, but I would expect someone with any sort of financial or mathematical background to know this.
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Post by ca on Feb 11, 2011 14:11:01 GMT -5
Yeah if in a given time frame the market goes up but first goes down then back up again, DCA over that time will get you better off than lump summing at the beginning if your timing works out that way. But it's riskier because the market may not go down at all, it may just go up, in whcih case your return will be less.
All about what you expect the market to do. With the way it has been since 2008's crash, with up / down / up / down / massively up lately DCA probably has been the way to go. Interesting discussion anyway.
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runewell
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Post by runewell on Feb 11, 2011 14:31:20 GMT -5
We want to maximize our returns subject to an acceptable variability in our investment choices; generally the higher the risk, the higher the reward. But now we are speaking of choice of investment(s), not DCA.
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Post by ca on Feb 11, 2011 14:43:09 GMT -5
DCA does make investing a bit less scary for a novice investor with a big chunk of money when there are ups and downs in the market I suppose. If the market goes up they are happy and if the market goes down they are buying more stock for the same money so it's more win/win.
It still kind of feels like trying to time the market to me tho.
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hoops902
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Post by hoops902 on Feb 11, 2011 15:06:41 GMT -5
DCA does make investing a bit less scary for a novice investor with a big chunk of money when there are ups and downs in the market I suppose. If the market goes up they are happy and if the market goes down they are buying more stock for the same money so it's more win/win. It still kind of feels like trying to time the market to me tho. DCA feels like timing the market? Or investing lump sum does? The way I read your statement sounds like you think DCA is, it's almost universally regarded as the opposite though. That investing lump sum at one point is trying to time the market while DCA is taking an average of multiple market points and therefore trying to eliminate market timing risk.
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