When Price Drops Occur (DCA and VII)

I looked at dollar cost averaging (DCA) and varying allocations in accordance with valuations (Valuation Informed Indexing VII). Varying allocations produces consistently high final balances. It removes the sensitivity of dollar cost averaging as to when price drops occur.

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 above 30 in Year 2.
P/E10 below 20 in Year 8.
P/E10 below 15 in Year 10.
P/E10 below 10 never.
20% rebalanced: 56,689.
50% rebalanced: 80,579.
80% rebalanced: 107,390.
Valuation Informed Indexing: 115,280.

Run 2.
P/E10 below 20 in Year 2.
P/E10 below 15 in Year 8.
P/E10 below 10 never.
20% rebalanced: 51,749.
50% rebalanced: 64,952.
80% rebalanced: 76,757.
Valuation Informed Indexing: 115,957.

Run 3.
P/E10 below 20 in Year 3.
P/E10 below 15 in Year 9.
P/E10 below 10 in Year 21.
20% rebalanced: 60,028.
50% rebalanced: 93,423.
80% rebalanced: 137,404.
Valuation Informed Indexing: 139,683.

Run 4.
P/E10 below 20 in Year 3.
P/E10 below 15 in Year 8.
P/E10 below 10 in Year 26.
20% rebalanced: 52,327.
50% rebalanced: 66,672.
80% rebalanced: 79,900.
Valuation Informed Indexing: 108,626.

Run 5.
P/E10 below 20 in Year 2.
P/E10 below 15 in Year 4.
P/E10 below 10 in Year 7.
20% rebalanced: 57,007.
50% rebalanced: 85,976.
80% rebalanced: 127,552.
Valuation Informed Indexing: 110,540.

Run 6.
P/E10 above 30 in Year 7.
P/E10 below 20 in Year 8.
P/E10 below 15 in Year 10.
P/E10 below 10 in Year 11.
20% rebalanced: 49,300.
50% rebalanced: 58,262.
80% rebalanced: 66,356.
Valuation Informed Indexing: 88,387.

Run 7.
P/E10 above 30 in Year 2.
P/E10 below 20 in Year 7.
P/E10 below 15 in Year 11.
P/E10 below 10 in Year 13.
20% rebalanced: 55,199.
50% rebalanced: 75,665.
80% rebalanced: 96,309.
Valuation Informed Indexing: 113,740.

Run 8.
P/E10 above 30 in Year 2.
P/E10 below 20 in Year 5.
P/E10 below 15 in Year 9.
P/E10 below 10 never.
20% rebalanced: 49,446.
50% rebalanced: 59,061.
80% rebalanced: 68,284.
Valuation Informed Indexing: 88,710.

Run 9.
P/E10 below 20 in Year 3.
P/E10 below 15 in Year 13.
P/E10 below 10 never.
20% rebalanced: 50,387.
50% rebalanced: 61,182.
80% rebalanced: 70,756.
Valuation Informed Indexing: 102,798.

Run 10.
P/E10 above 30 in Year 5.
P/E10 below 20 in Year 8.
P/E10 below 15 in Year 9.
P/E10 below 10 in Year 26.
20% rebalanced: 55,648.
50% rebalanced: 78,026.
80% rebalanced: 104,057.
Valuation Informed Indexing: 119,653.

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 115,957, 110,540.
P/E10 below 20 in Year 3: balances 139,683, 108,626, 102,798.
P/E10 below 20 in Year 5: balance 88,710.
P/E10 below 20 in Year 7: balance 113,740.
P/E10 below 20 in Year 8: balances 115,280, 88,387, 119,653.

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

P/E10 below 15 in Year 4: balance 110,540.
P/E10 below 15 in Year 8: balances 115,957, 108,626.
P/E10 below 15 in Year 9: balances 139,683, 88,710, 119,653.
P/E10 below 15 in Year 10: balances 115,280, 88,387.
P/E10 below 15 in Year 11: balance 113,740.
P/E10 below 15 in Year 13: balance 102,798.

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

P/E10 below 10 in Year 7: balance 110,540.
P/E10 below 10 in Year 11: balance 88,387.
P/E10 below 10 in Year 13: balance 113,740.
P/E10 below 10 in Year 21: balance 139,683.
P/E10 below 10 in Year 26: balance 108,626, 119,653.
P/E10 below 10 never: balances 115,280, 115,957, 88,710, 102,798.

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

139,683 and years 3, 9 and 21.
119,653 and years 8, 9 and 26.
115,957 and years 2, 8 and never.
115,280 and years 8, 10 and never.
113,740 and years 7, 11 and 13.
110,540 and years 2, 4 and 7.
108,626 and years 3, 8 and 26.
102,798 and years 3, 13 and never.
88,710 and years 5, 9 and never.
88,387 and years 8, 10 and 11.

Data Analysis

In all instances, owning stocks proved beneficial.

In all instances, an 80% stock allocation was best among fixed allocations.

Varying allocations produced the largest final balance in 9 out of 10 instances. In the single instance where the 80% fixed allocation did better, the varying allocation still produced a high final balance (110,540).

Varying allocations with P/E10 produces consistently high balances when compared to using 2% TIPS alone or any fixed stock/TIPS allocation.

Varying allocations with P/E10 removes the sensitivity as to when price drops occur. Any remaining relationship is weak.

Conclusions

Varying allocations with P/E10 produces consistently high balances when dollar cost averaging.

Varying allocations with P/E10 removes the sensitivity as to when price drops occur.

Have fun.

John Walter Russell
May 18, 2008