When Price Drops Occur (Dollar Cost Averaging)

I looked at dollar cost averaging with fixed allocations. The sooner P/E10 falls below 20, the better. The sooner that P/E10 falls below 10, if it happens, the better.

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 with fixed allocations. P/E10 values are in “Current Years” in the “Portfolio Allocation” box.

Run 1.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 6.
P/E10 below 10 in Year 10.
20% rebalanced: 57,702.
50% rebalanced: 86,578.
80% rebalanced: 125,211.
100% stocks: 156,720.

Run 2.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 5.
P/E10 below 10 in Year 9.
20% rebalanced: 55,448.
50% rebalanced: 77,072.
80% rebalanced: 100,120.
100% stocks: 114,324.

Run 3.
P/E10 below 20 in Year 5.
P/E10 below 15 in Year 6.
P/E10 below 10 in Year 10.
20% rebalanced: 59,139.
50% rebalanced: 92,449.
80% rebalanced: 140,029.
100% stocks: 181,564.

Run 4.
P/E10 below 20 in Year 10.
P/E10 below 15 in Year 12.
P/E10 below 10 in Year 15.
20% rebalanced: 48,191.
50% rebalanced: 56,169.
80% rebalanced: 64,501.
100% stocks: 70,087.

Run 5.
P/E10 below 20 in Year 5.
P/E10 below 15 in Year 8.
P/E10 below 10 never.
20% rebalanced: 54,448.
50% rebalanced: 73,687.
80% rebalanced: 94,202.
100% stocks: 107,292.

Run 6.
P/E10 below 20 in Year 12.
P/E10 below 15 in Year 16.
P/E10 below 10 never .
20% rebalanced: 47,623.
50% rebalanced: 53,983.
80% rebalanced: 59,667.
100% stocks: 62,875.

Run 7.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 7.
P/E10 below 10 never .
20% rebalanced: 55,922.
50% rebalanced: 81,406.
80% rebalanced: 116,061.
100% stocks: 144,957.

Run 8.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 4.
P/E10 below 10 in Year 7.
20% rebalanced: 63,785.
50% rebalanced: 110,178.
80% rebalanced: 181,979.
100% stocks: 248,310.

Run 9.
P/E10 below 20 in Year 9.
P/E10 below 15 in Year 22.
P/E10 below 10 never .
20% rebalanced: 58,459.
50% rebalanced: 89,191.
80% rebalanced: 130,492.
100% stocks: 163,973.

Run 10.
P/E10 below 20 in Year 5.
P/E10 below 15 in Year 9.
P/E10 below 10 in Year 15.
20% rebalanced: 50,881.
50% rebalanced: 63,984.
80% rebalanced: 78,634.
100% stocks: 88,981.

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: balances 156,720, 114,324, 144,957, 248,310.
P/E10 below 20 in Year 5: balances 181,564, 107,292.
P/E10 below 20 in Year 9: balances 163,973, 88,981.
P/E10 below 20 in Year 10: balance 70,087.
P/E10 below 20 in Year 12: balance 62,875.

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

P/E10 below 15 in Year 4: balance 248,310.
P/E10 below 15 in Year 5: balance 114,324.
P/E10 below 15 in Year 6: balances 156,720, 181,564.
P/E10 below 15 in Year 7: balance 144,957.
P/E10 below 15 in Year 8: balance 107,292.
P/E10 below 15 in Year 9: balance 88,981.
P/E10 below 15 in Year 12: balance 70,087.
P/E10 below 15 in Year 16: balance 62,875.
P/E10 below 15 in Year 22: balance 163,973.

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

P/E10 below 10 in Year 7: balance 248,310.
P/E10 below 10 in Year 9: balance 114,324.
P/E10 below 10 in Year 10: balances 156,720, 181,564.
P/E10 below 10 in Year 15: balances 70,087, 88,981.
P/E10 below 10 never: balances 107,292, 62,875, 144,957, 163,973.

Here are the P/E10 thresholds versus the ordered Year 30 balances:
248,310 and years 4, 4 and 7.
181,564 and years 5, 6 and 10.
163,973 and years 9, 22 and never.
156,720 and years 4, 6 and 10.
144,957 and years 4, 7 and never.
114,324 and years 4, 5 and 9.
107,292 and years 5, 8 and never.
88,981 and years 5, 9, and 15.
70,087 and years 10, 12 and 15.
62,875 and years 12, 16 and never.

Data Analysis

In all instances, a 100% stock allocation was best among fixed allocations.

The strongest relationship is when P/E10 falls below 20. It is very good news if it falls below 20 within the first 5 years. Year 9 was mixed, but Years 10 and 12 confirm that earlier is better.

The relationship for P/E10 falling below 15 is almost the same. Yet, it is inconclusive since the longest wait (22 years) ended up providing an excellent final balance.

The relationship when P/E10 falls below 10 is exceptionally strong when it happens. But it does not always happen. When P/E10 does not fall below 10, final balances can end up being high anyway.

Conclusions

If you are dollar cost averaging while maintaining a fixed stock allocation, choose 100% stocks and hope for prices to fall sooner and deeper rather than later and gentler. You will do well if P/E10 falls below 20 within the first 5 years or so. You will do exceptionally well if P/E10 falls below 10 within the first 8 years or so.

You can count on P/E10’s falling below 20. You cannot count on its falling below 10 (within the next 30 years).

Have fun.

John Walter Russell
May 15, 2008
Corrected: May 19, 2008