Dollar Cost Averaging - The Role of Cognitive Error

Abstract

Dollar Cost Averaging (DCA) has been shown to be mean-variance inefficient, yet it remains a very popular strategy. Recent research has attempted to explain its popularity by assuming more complex risk preferences. This paper rejects such explanations by demonstrating that DCA is sub-optimal regardless of preferences over terminal wealth. Instead, this paper identifies the cognitive error in the argument that is normally put forward in favor of the strategy. This gives us a simpler explanation for DCA’s continued popularity: That investors are making a mistake (a misleading comparison) when assessing the benefits of DCA. Unlike previous explanations, this suggests that using DCA may be detrimental to investors