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When Stock Prices Are High What You Can Do With Dca
Overview
Many General Mills employees and retirees have told us how difficult it feels to evaluate certain investment strategies. To evaluate DCA as an investment strategy we will compare it to lump sum investing for rolling 10-year investment periods with monthly steps. This means that starting with the first available month we will examine DCA and lump sum investing through the following decade of returns, and then move the start point one month ahead. For most data series in our sample, this results in 485 10-year periods. For Canada, we have 652 periods, and 1013 for the US. We will evaluate a 12-month DCA implementation, which means splitting up a lump sum into 12 equal monthly investments, against a single lump sum investment. The following chart shows an approximate allocation between cash and stocks over the course of a 12-month DCA period for $1,000,000 of starting cash.
Figure 1 – Dollar-Cost Averaging Illustration
Source: Benjamin Felix, Portfolio Manager, PWL Capital Inc.
In our model, the cash will earn interest at the rate of One-Month US Treasury Bills while it is waiting to be invested. The portfolios are 100% invested in stocks when fully implemented. All analysis has been conducted in US dollars using monthly returns for One-Month US Treasury Bills and the six global stock markets listed in Table 1.
Table 1 – Stock Market Indexes
Source: Benjamin Felix, Portfolio Manager, PWL Capital Inc.
In order to evaluate LSI relative to DCA, we have chosen to look at the ending performance of an investment after 10 years. First, we evaluated the full data series for each market to understand the average outcomes. We isolated the most extreme bad outcomes for LSI to examine how DCA performed in those periods. Knowing that we cannot predict when LSI will have its worst outcomes, we then compared LSI to DCA during bear markets and when stock prices are high.
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Figure 2 – Historical Monthly US Equity Risk Premium
Data source: Dimensional Returns Web, CRSP, PWL Capital Inc.
The monthly US equity premium has been remarkably consistent, within a range, throughout history. It has an arithmetic average of 0.65%, and it has been positive 60% of the time. There tend to be periods, visible in Figure 2, where the monthly premium becomes more volatile; volatility clustering is a well-known phenomenon. Over periods longer than one month we also observe characteristic negative skewness - frequent small gains and a few extreme losses.
Given the nature of stock returns, we would expect a stock investor to achieve positive returns with roughly the same frequency as the equity risk premium being positive. For the remainder of this paper, we will be comparing lump sum investing to dollar-cost averaging in terms of absolute returns, as opposed to observing their risk premiums. US stock returns have been positive in absolute terms 63% of the time in the historical data.
For most markets, and on average across markets, we find that roughly two-thirds of the time LSI beats DCA over 10-year periods in terms of ending assets. The exception is Japan which is unsurprising given its unique long-term stock market outcome; Japan’s equity market has trailed One-Month US Treasury Bills since 1990.
Table 2 – LSI vs. DCA for 10-Year Historical Periods
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
The basic insight that we draw from this result is that, on average, LSI leads to greater ending wealth than DCA. To quantify the extent to which LSI tends to beat DCA we examined the 10-year annualized performance difference for the full sample. An annualized figure stated as a percentage makes for an easy comparison to familiar items like fees and withholding taxes. On average, DCA is leaving a meaningful amount of expected returns on the table at 0.38% annualized over ten years in the historical data; this should not be a surprise considering that DCA delays exposure to higher expected returning stocks.
Table 3 – LSI vs. DCA Annualized 10-Year Performance Difference
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
Comparing average outcomes is interesting but it does not speak to the dispersion of outcomes. Even if DCA is worse on average in terms of expected average outcomes, maybe it offers some protection on the downside. To assess this, we calculate the difference in annualized returns for LSI and DCA over 10-year periods and sort the data into percentiles. The 10th percentile is the bottom 10% of outcomes, the 50th percentile is the median, and the 90th percentile is the top 10%.
Table 4 – Difference in Annualized Returns (LSI – DCA)
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
It should be clear from Table 4 that LSI is beating DCA by a healthy margin on average. In the best 10% of outcomes (90th percentile), more has been gained by LSI over DCA than what has been lost in the worst 10% of outcomes. The median outcome is positive, and the distribution is negatively skewed. None of this should be a surprise considering the positive expected risk premium of stocks over treasury bills, and the left-skewed distribution of stock returns. Figure 3 shows the shape of the distribution of the differences in outcomes for LSI less DCA in terms of 10-year annualized returns.
Figure 3 – Distribution of Differences in 10-Year Annualized Outcomes (LSI - DCA)
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
At the most extreme, the far left and right tails of the distribution, LSI does look worse than DCA. This observation is consistent with a negatively skewed distribution; we see that most of the outcomes are good, but the worst outcomes are more extreme than the best outcomes. This validates the idea that DCA might be able to offer protection from the worst outcomes, but it comes at a significant cost in terms of expected returns.
Sorting by the difference between LSI and DCA lets us think about the total distribution of outcomes for DCA relative to LSI, but we are now interested in how DCA does when LSI does poorly relative to the full set of LSI outcomes. To examine this, we sort historical outcomes by LSI ending assets and observe how DCA performs when LSI has its worst 10% of historical outcomes. Framed differently, if we knew that the next 10 years would be among the worst in history for a lump sum investment, could we count on DCA to improve the outcome?
Table 5 – LSI vs. DCA in the 10th Percentile LSI Historical Periods
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
In half of our markets, LSI still beats DCA most of the time even when LSI has delivered its worst historical outcomes; this is also true with an equal-weighted average of all markets in the sample. The results are not as strongly in favor of LSI as the full data series but remember that we have intentionally selected the worst LSI outcomes for this sample. While the number of outcomes is evenly matched, the bad outcomes in this case are worse in magnitude than the good ones. The result is a negative difference in annualized 10-year performance. This should not be surprising considering our intentional selection of the worst LSI outcomes in the sample.
Table 6 – Difference in Annualized Returns for 10th Percentile LSI Outcomes (LSI – DCA)
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
Even under artificial conditions of a known bad future outcome for LSI, DCA offers less than a 50% shot at an improvement. DCA does however offer an edge when the magnitude of positive and negative outcomes is considered – despite the roughly even split between good and bad outcomes, the bad outcomes are worse than the good outcomes are good. This seems to give credence to the mythical ability of DCA to improve an extremely bad LSI outcome. An important nuance in the data is that the worst LSI outcomes relative to other LSI outcomes do not correspond with the worst LSI outcomes relative to DCA outcomes. The most extreme instances of underperformance for LSI relative to DCA have less to do with the LSI outcome being extremely bad and more to do with the DCA outcome being extremely good. In other words, lucky timing for DCA, as opposed to avoiding unlucky timing for LSI, drives the difference in the most extreme cases.
Given that it is impossible to predict which time periods will result in the worst outcomes for a lump sum investment, we next turn to two signals commonly believed to offer forward-looking insight into future investment returns.
Table 7 – LSI vs. DCA in Historical Bear Markets
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
We again find that LSI produces a better outcome than DCA most of the time in most countries in the sample. General Mills employees and retirees should note that the US experience is significantly impacted by the enormous volatility and seemingly perpetual market drops in the 1930s. We find that, on average, LSI beats DCA by a 10-year annualized 0.25% when the investment period begins with the month after a drop of 20% or more has occurred. Echoing the experience of the full data series we also see that there has historically been more to gain from LSI in the 90th percentile of outcomes than there has been to lose in the 10th percentile. DCA is not offering protection from bad outcomes without also exposing us to a greater risk of missing good outcomes.
Table 8 – Difference in Annualized Returns Starting at Bear Markets (LSI – DCA)
Data source: Dimensional Returns Web, CRSP, MSCI, S&P Dow Jones Indices, PWL Capital Inc.
It's important for General Mills employees to keep in mind that our trigger to begin the investment period is a 20% drop. In some cases, a 20% drop is followed by more drops, while in other cases it is followed by a rebound. Based on the data in Tables 7 and 8 we can see that rebounds are more impactful, on average than further drops. This results in LSI delivering a better result than DCA most of the time, even during periods of market volatility.
Table 9 – LSI vs. DCA when Stock Prices are High Relative to all History
Data source: Dimensional Returns Web, CRSP, Barclays Research, PWL Capital Inc.
While it may seem concerning, this observation suffers from a massive bias: at any point in time we do not have the full set of past and future Shiller CAPE data to base a decision - we only have past data in our possession. We adjust for this by measuring the market’s expensiveness only relative to historical data for each data point. For example, for January 1926 we are comparing the Shiller CAPE to the set of data from February 1872 to January 1926, not from February 1872 to May 2020 to test for expansiveness. In this case, LSI beats DCA 63.70% of the time.
Table 10 – LSI vs. DCA when Stock Prices are High Relative to Backward-looking History
This exercise is to remind General Mills employees and retirees that while valuations may look high at a point in time, they can always get higher. Japan might be a particularly interesting case study on the usefulness of market valuations in making the LSI vs. DCA decision. We have less data for Japan, so instead of comparing historical Japanese data, we will compare Japanese valuations to US data to determine expensiveness. The highest level of the monthly Shiller CAPE for the full US historical data series is 44.19 which occurred in December 1999. Japan exceeded this level in May 1986 with a Shiller CAPE of 44.31. While the Japanese market did eventually crash in 1990, there are 29 monthly observations following May 1986 where LSI beats DCA by a wide margin. Even starting in November 1988, with a Shiller CAPE of 72.07, LSI beats DCA in Japan in terms of 10-year annualized returns.
It is well-known that future returns tend to be relatively low when valuations are relatively high. Despite this, using valuation as a signal to time the LSI vs. DCA decision has historically resulted in unfavorable outcomes most of the time.
Despite the statistical evidence in favor of LSI, there is a meaningful psychological risk to investing in a lump sum. For many General Mills investors, losing money in the stock market is psychologically, and in some cases physiologically painful. There is evidence from behavioral finance suggesting that acts of commission are more painful than acts of omission. Making the decision to buy stocks today is an act of commission while deciding not to buy stocks is an act of omission. Buying stocks on a given day and then watching them fall is more psychologically painful than not buying stocks and watching them rise, even if the economic impact is identical. DCA could be viewed as diversifying acts of commission over time to reduce the potential for a psychologically painful outcome.
If DCA seems like a solution to avoiding pain when investing new money, we think that it is a reasonable strategy. However, we also think that if the fear of loss is so great that DCA needs to be employed to make an asset allocation decision palatable, that asset allocation may be too aggressive. It should feel comfortable to invest a lump sum in a risk-appropriate portfolio. We do not want to imply that DCA should never be employed, but we do believe that if it feels necessary to use DCA in order to implement an asset allocation decision, it may be wise to revisit the portfolio altogether.
TRG takes a teamwork approach in providing the best possible solutions for our clients’ concerns. The Team has a conservative investment philosophy and diversifies client portfolios with laddered bonds, CDs, mutual funds, ETFs, Annuities, Stocks and other investments to help achieve their goals. The team addresses Retirement, Pension, Tax, Asset Allocation, Estate, and Elder Care issues. This document utilizes various research tools and techniques. A variety of assumptions and judgmental elements are inevitably inherent in any attempt to estimate future results and, consequently, such results should be viewed as tentative estimations. Changes in the law, investment climate, interest rates, and personal circumstances will have profound effects on both the accuracy of our estimations and the suitability of our recommendations. The need for ongoing sensitivity to change and for constant re-examination and alteration of the plan is thus apparent.
Therefore, we encourage you to have your plan updated a few months before your potential retirement date as well as an annual review. It should be emphasized that neither The Retirement Group, LLC nor any of its employees can engage in the practice of law or accounting and that nothing in this document should be taken as an effort to do so. We look forward to working with tax and/or legal professionals you may select to discuss the relevant ramifications of our recommendations.
Throughout your retirement years we will continue to update you on issues affecting your retirement through our complimentary and proprietary newsletters, workshops and regular updates. You may always reach us at (800) 900-5867.
How can employees of General Mills, Inc. maximize their benefits under the BCTGM Retirement Plan, and what factors are considered in determining pension amounts for those nearing retirement? This question aims to explore the intricate details of how General Mills, Inc. structures its pension benefits to support employees’ future financial stability. It's important for employees to understand the value of their years of service and how this affects their ultimate pension payout as they approach retirement.
Maximizing Benefits under the BCTGM Retirement Plan: Employees of General Mills can maximize their benefits under the BCTGM Retirement Plan by understanding how their years of service and negotiated benefit levels directly affect the pension they receive. The pension amount is determined by the length of service and a defined benefit formula based on the number of years of Benefit Service accrued. As employees approach retirement, they should consider whether they meet eligibility criteria for early or normal retirement, as these factors influence the ultimate pension payout(General_Mills_2024_Pens…).
What are the eligibility requirements for participating in the BCTGM Retirement Plan at General Mills, Inc., and how does this participation impact future retirement benefits? Employees should be well-informed about what constitutes eligibility to participate in the retirement plan. Understanding criteria such as service length, employment status, and union participation is crucial, as it directly relates to their ability to accrue retirement benefits.
Eligibility Requirements for BCTGM Retirement Plan: To participate in the BCTGM Retirement Plan, employees must be regular employees of General Mills covered by a collective bargaining agreement. Eligibility is automatic after completing a probationary period. Participation impacts future retirement benefits as employees begin to accrue pension benefits based on years of service, which contributes to their final payout during retirement(General_Mills_2024_Pens…).
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Federal Law Protections and PBGC's Role: The BCTGM Retirement Plan is protected under federal law, ensuring that employees’ retirement benefits are safeguarded. The Pension Benefit Guaranty Corporation (PBGC) insures vested benefits, including disability and survivor pensions, up to certain limits. This protection provides employees with assurance that their pensions are protected, even in the event of plan termination(General_Mills_2024_Pens…).
How does General Mills, Inc. address the complexities of vesting in the BCTGM Retirement Plan, and what can employees do if they are concerned about their vested rights? Vesting is a key concept that affects employees' access to benefits over their careers. Employees need to understand the vesting schedule outlined by General Mills, Inc. and the implications it has on their retirement plans.
Vesting in the BCTGM Retirement Plan: Employees vest in the BCTGM Retirement Plan after completing five years of Eligibility Service or upon reaching age 65. Once vested, employees have a non-forfeitable right to their pension benefits, which means they retain their pension rights even if they leave the company before reaching retirement age(General_Mills_2024_Pens…).
What options are available to employees of General Mills, Inc. if they experience a change in their employment status after being vested in the BCTGM Retirement Plan, and how might this impact their future retirement pensions? This question prompts discussion on the plan's provisions regarding reemployment and what employees should be aware of when considering changes to their employment status.
Impact of Employment Status Changes on Pension: If an employee's status changes after being vested in the BCTGM Retirement Plan, such as leaving the company, they may still be entitled to pension benefits. The plan outlines provisions for reemployment and how prior service years are counted toward future pension calculations. Employees who are reemployed may have their previously earned service restored(General_Mills_2024_Pens…).
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Coordination with Social Security Benefits: The BCTGM Retirement Plan operates in addition to Social Security benefits. There are no direct offsets between the pension and Social Security benefits, meaning employees receive both independently. However, employees should be aware of how the timing of drawing Social Security and pension benefits may affect their overall financial situation(General_Mills_2024_Pens…).
What steps must employees of General Mills, Inc. take to initiate a claim for benefits under the BCTGM Retirement Plan, and how does the claims process ensure fairness and transparency? A clear comprehension of the claims process is essential for employees to secure their pension benefits. This question encourages exploration of the procedures in place to assist employees in understanding their rights and options.
Claiming Benefits under the BCTGM Retirement Plan: Employees must terminate employment before claiming their BCTGM Retirement Plan benefits. The claims process involves submitting the required forms, and employees must ensure they provide all necessary documentation for a smooth process. The pension is generally paid monthly, with lump-sum options available under specific circumstances(General_Mills_2024_Pens…).
How does the retirement benefit formula of the BCTGM Retirement Plan operate, and what specific factors should an employee of General Mills, Inc. consider while planning for retirement? Delving into the calculations involved in determining retirement benefits is important for employees to understand how their service years and other contributions come together to form their final retirement payout.
Retirement Benefit Formula: The retirement benefit formula is calculated based on the years of Benefit Service and a defined benefit level. As of 2024, for each year of Benefit Service, employees receive $87 per month (increasing to $88 after June 1, 2025). Planning for retirement involves considering how long they will work and the benefit level in place at the time of retirement(General_Mills_2024_Pens…).
What additional resources or support does General Mills, Inc. provide to assist employees in planning their retirement and ensuring they make the most of their benefits offered under the BCTGM Retirement Plan? Understanding the tools and resources available can empower employees to take proactive steps in managing their retirement plans effectively.
Resources for Retirement Planning: General Mills offers resources like the Benefits Service Center and online portals (e.g., www.mygenmillsbenefits.com) to assist employees with retirement planning. These tools help employees understand their benefits, calculate potential payouts, and explore options for maximizing their retirement income(General_Mills_2024_Pens…).
How can employees contact General Mills, Inc. for further information about the BCTGM Retirement Plan or specific queries related to their retirement benefits? This question is crucial so employees know the appropriate channels for communication and can seek clarification on any concerns they may have regarding their retirement planning.
Contact Information for Plan Inquiries: Employees can contact General Mills for more information about the BCTGM Retirement Plan through the Benefits Service Center at 1-877-430-4015 or visit www.mygenmillsbenefits.com. This contact provides direct access to support and answers to questions about their retirement benefits(General_Mills_2024_Pens…).
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