The Investment Scientist

Archive for June 2017

Investment-Planning_Lump-Sum-vs-Dollar-Cost-Averaging.jpgRecently, I shared a true story in which I set up a client’s 401k plan five years ago with periodic (bi-weekly) contributions and equal investments into both a US stock index fund and an international stock index fund. Despite the fact that the US index (fund) has outperformed the international index (fund) by a huge margin: 86% vs 29% over the last five years, my client now has more money in the international fund than in the US fund. What gives? I invited my readers to think about it and give me their explanations. Now it’s time to reveal the answer: it’s dollar cost averaging!

Let me show you a stylized example in a three time-period world. There are two indexes. Index A goes from 100 to 105, then 110. Index B goes from 100 to 80, then 100. It’s clear that index A dominates index B since the total return of index A is 10%, that of index B is 0%. Yet an investor who makes equal $100 periodic investments in both index A and B will have more money in B at the end. Here is the math …

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If you look at this chart covering the last five years, the red line representing the US market and blue representing international markets, which market do you think would have made you more money? It’s a no brainer right? The US market went up nearly 90%, while the international markets went up less than 30%. Of course it’s the US market, right?

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I thought so too until I reviewed a client’s 401k account recently. I set up his account about five years ago. 

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Identity-Theft.gifOne day two years ago, I got an email from a client of mine. In a very concise manner, he told me he was in Singapore for a business deal and he needed to wire $500k from his investment account to a bank account in Singapore.

To raise the money, I would need to sell some of his highly appreciated investments. I didn’t want him to be surprised by capital gain taxes, so I replied with an explanation of the tax implications.

After that, I was ready to wire the money, so I sent him a short message: “You know our standard procedure, any time a client wants to move more than $10k, he needs to call me to tell me in his own voice.” I totally expected my phone would ring right away.

Instead, I got another email: “I am in Singapore, I don’t have a phone with me, take this email as my authorization to wire the money.”

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

Twitter: @mzhuang

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