When Price Drops Occur (DCA and VII variant 2)

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.

This version produces results similar to 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 2.
P/E10 below 15 in Year 4.
P/E10 below 10 never.
20% rebalanced: 54,915.
50% rebalanced: 75,858.
80% rebalanced: 99,551.
DCA VII 2: 103,916.

Run 2.
P/E10 below 20 in Year 2.
P/E10 below 15 in Year 13.
P/E10 below 10 in Year 24.
20% rebalanced: 50,813.
50% rebalanced: 63,015.
80% rebalanced: 75,347.
DCA VII 2: 87,161.

Run 3.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 10.
P/E10 below 10 in Year 11.
20% rebalanced: 49,276.
50% rebalanced: 57,588.
80% rebalanced: 63,508.
DCA VII 2: 90,921.

Run 4.
P/E10 below 20 in Year 3.
P/E10 below 15 in Year 3.
P/E10 below 10 in Year 9.
20% rebalanced: 57,074.
50% rebalanced: 83,373.
80% rebalanced: 114,899.
DCA VII 2: 142,038.

Run 5.
P/E10 below 20 in Year 2.
P/E10 below 15 in Year 11.
P/E10 below 10 in Year 13.
20% rebalanced: 55,556.
50% rebalanced: 77,396.
80% rebalanced: 102,142.
DCA VII 2: 133,243.

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 2: balances 103,916, 87,161, 133,243.
P/E10 below 20 in Year 4: balance 90,921.
P/E10 below 20 in Year 3: balance 142,038.

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

P/E10 below 15 in Year 3: balance 142,038.
P/E10 below 15 in Year 4: balance 103,916.
P/E10 below 15 in Year 10: balance 90,921.
P/E10 below 15 in Year 11: balance 133,243.
P/E10 below 15 in Year 13: balance 87,161.

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

P/E10 below 10 in Year 9: balance 142,038.
P/E10 below 10 in Year 11: balance 90,921.
P/E10 below 10 in Year 13: balance 133,243.
P/E10 below 10 in Year 24: balance 87,161.
P/E10 below 10 never: balance 103,916.

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

142,038 and years 3, 3 and 9.
133,243 and years 2, 11 and 13.
103,916 and years 2, 4 and never.
90,921 and years 4, 10 and 11.
87,161 and years 2, 13 and 24.

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 seems to be sensitive as to when prices fall below P/E10=15, but not when P/E10=20 and P/E10=10. 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 almost as good 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