Adding to our previous discussion around the benefits that volatility generates for dollar cost averaging strategies, we now consider whether those benefits can be exploited by the fully invested. Again, the excess returns come from the fact that DCA exploits the “buy more low” and “buy less high” aspect of fixed-dollar investments, and are enhanced by additional volatility.
So, are the benefits derived from DCA exclusively available to those making bi-weekly allocations? Good news, the answer is no. In fact, every investor who is already fully invested can structure their portfolio approach so as to gain additional benefits from volatility over time – just like DCA. This is achieved by executing a strategy of “intra-portfolio dollar cost averaging”.
Traditional DCA takes new cash flows and buys more of relatively cheap assets and less of relatively expensive assets. For investors who are not adding meaningful additional cash flows to their portfolio (those with the most significant account sizes), a comparable strategy can add additional returns in excess of what the underlying investments in their portfolios will generate.
By systematically buying relatively cheap assets with proceeds derived from selling relatively expensive assets, a fully invested portfolio can generate additional gains over time. The same concept as DCA applies, as investors will improve the average price of their investments over time, and ultimately earn more than the sum of the portfolio’s parts. It is also true that increased volatility can enhance those excess returns. This argument applies even a step further, in that intra-portfolio dollar cost averaging is the only way a fully invested portfolio can earn more than the sum of its parts.
Another less technical term for intra-portfolio dollar cost averaging is ‘rebalancing’. Unfortunately, rather than being exploited, rebalancing is typically an afterthought, and is rarely considered a domain to which you can apply a systematic process and generate additional returns. When executed with a system that exploits volatility like its DCA brethren, rebalancing can be an extremely powerful portfolio tool – we at Strategic Alpha have measured excess gains at the portfolio level of 80 basis points per year.
Considering all of the effort that goes into generating investment selection alpha (or ‘fee reduction alpha’ for the passive strategists among us), it seems worthwhile to consider other areas of potential gain that have gone unexploited for so long. We invite you to consider our studied approach at www.Strategic-Alpha.com.
Dave Donnelly is the Founder and CEO of Strategic Alpha, a rebalancing service dedicated to helping financial advisors improve client outcomes. www.Strategic-Alpha.com