Yesterday former Merrill broker and municipal bond investor Suze Orman, CFP, sent out word to her legions of followers that they should "be extra careful in how you invest at this point in time." The Oracle of Berkeley continued:
A pullback from here shouldn’t be surprising given the fast and steep rise. Meanwhile there’s the evolving concern that Greece’s debt problems could spread to other countries given the inter-connectedness of all our economies. Add it all up and there’s more to worry about than cheer.
I am writing down the date she wrote this "2-8-10" and that day’s S&P close "1056.74" on a post-it I am placing on the wall here at BMA World Headquarters. I would encourage my legion of followers to do the same, so that together we can bask in the wisdom and foresight of the Great Suze.
Orman goes so far as to recommend that investors act on her vision through dollar cost averaging. That’s more than a little asinine, but before discussing it, let me dwell a bit on her reasons for worry. It’s not every day that Suze shares her market timing insights. (In fact, I think this may be the first time ever.)
Greece is certainly a real issue. But it is hardly a storm cloud on the horizon. It is already here raining on us. And it could be the sky is starting to clear. The same day Suze’s pronouncement was issued, the news broke that the other EU members were grudgingly working on a plan to bail Greece out, which is pretty much what everybody was expecting would happen all along.
Personally, I think the importance of Greece in the recent market swoon is a bit exaggerated. The markets are worried about a country with out of control government deficits, but it’s not Greece.
And Orman’s statement that "A pullback from here shouldn’t be surprising given the fast and steep rise" is a bit odd. The S&P went up a miraculous 57.5% in the seven months from March 9th, 2009. (If you haven’t lately, read the post I wrote that day saying the market was crazy cheap.) But since then, in the four months since October 8, 2009, the market has been roughly flat. So why expect a pullback now?
The problem with Suze’s prognostications is not that they are half-baked conventional wisdom, but that they are stale half-baked conventional wisdom.
So on to dollar cost averaging. DCA is the Monty Hall Problem of personal finance. You either quickly see why it makes no sense or no amount of reasoned argument will persuade you to give it up. The basic idea is that instead of investing all your money in one go, you dribble it out over time and so wind up with a buy-in price that is the average price over a longer period rather than the single price you would get today.
DCA has a lot of emotional appeal, for reasons explained rather well by Ken French in this video. From a non-emotional and rational point of view, it almost, but not quite, makes sense. The averaging of prices over time is not really diversifying in the usual meaning of the term. The returns on each individual purchase are perfectly correlated. All you are doing is swapping today’s price for the average price over some time period.
To see why there is generally no reason to prefer the average price, consider the choice between three prices: today’s price, the price in a year, and the average price over the course of the next year. Assuming you want to buy a stock, which price do you choose? That depends. Do you think the stock is going to go up in the next year? Then today’s price is most likely to be the lowest. If you think the stock is going down, then the price a year from now makes most sense. The average price would only be best if you expected the stock to go down and then up during the year. (Don’t confuse this with volatility: average would be a disastrous choice if it went up then down.)
I wrote about DCA last fall. I gave as an illustrative example a case where a person had $12,000 to invest and was considering putting it all in the market at once or making 12 $1,000 monthly investments. Several commenters on that post objected that this was a pointlessly unlikely scenario.
In a coincidence that approaches creepy, Suze writes
For those of you who are about to do an IRA ROLLOVER or a ROTH Conversion and you are all in cash, I would not take that entire amount of cash and invest it all at once. I would absolutely divide that money up by dividing it by 12 and invest that amount month in and month out using the Dollar Coast Averaging technique I talked about above. So if you are rolling over $12,000 I would divide $12,000 by 12 which is $1000 and invest $1000 every month or if that is too much for you divide $12,000 by 4 which is $3000 and invest every four months. [Can't this woman hire a copy editor? Honorable mention to the best explanation in the comments of what dollar coast averaging might be.]
So not only does Suze advocate the use of smoke-and-mirrors DCA, she apparently believes that IRA rollovers and Roth conversions involve going to all cash. And that it would make sense to do something differently with your investments if you were in the midst of a rollover or conversion than if the accounts were just sitting there.
Still, the oracle has spoken.