Dollar-Cost Averaging vs. Percentage-Based Budgeting
Kyle and I had the most ridiculous fight about our budget two weeks ago. Our positions were only slightly different, yet we were so entrenched we couldn’t come to a resolution and had to drop the argument for the night! Both of us are very opinionated and stubborn and I am definitely not the only PF nerd in the family.
I’ve been preaching percentage-based budgeting on EPF basically since the start of the blog. What I mean by that is that our spending and saving should be in balance based on percentages that we set out in advance. Sticking to these principles keep us honest both in transitions and when our expenses are stable. For example, our overall saving and spending is fairly well aligned with the balanced money formula, with a few adjustments.
Right now the important percentage-based components of our budget are our giving and retirement saving rates. Each month, we transfer 10% of our gross income from the previous month to our church (plus some additional amounts to other recipients) and 18% to our Roth IRAs. The minimum we want to save each month into our Roth IRAs is 15%, though we’ve edged the percentage up a bit over the last few years, basically by rounding up each time we make an adjustment.
Kyle got a raise last month when he transitioned from being a grad student to a postdoc, meaning that we need to bump up our retirement contributions. However, I’ll be unemployed after August, so we’ll have to reduce our retirement contributions. How exactly to adjust our retirement savings as we go through these transitions was the subject of our very silly fight.
Emily’s position: We should follow our percentage-based budget exactly by contributing 15% of the previous month’s income to our Roth IRAs.
Kyle’s position: We should contribute 15% of our income but spread it out over several months to dollar-cost average (DCA) into the market.
Basically, I want Kyle to set up a recurring transfer to his Roth for 15% of his new gross income. I’ll keep my contribution the same as it has been through September (for August’s income, my last paycheck) and then cancel the recurring payment. I’ll set up manual transfers for whatever irregular income I have in the fall month-by-month. (We do manual transfers for all of Kyle’s income from our church since it is irregular, so we know it’s pretty easy.)
Kyle objects to my plan because to him it feels like lump sum investing or market timing. He is super into DCA and wants contribute the same amount of money each month from August through the end of the year, plus investing 15% of whatever I earn irregularly.
I am also into DCA from regular paychecks, but I know that when you have a bolus of money to invest, lump sum investing is likely to be the better strategy over dollar-cost averaging. That’s not about market timing, just that the general long-term trend is for stock values to increase. Plus, the changes in our employment status are unconnected with the market. But Kyle is really uncomfortable with the idea of saving a lot for two months and then not as much for several and wants to defer some of the savings from our higher-income months to lower-income ones.
I object to Kyle’s plan because I think it’s arbitrary. We should make our savings decisions based on the past, not speculations about the future. We don’t even know for how many months Kyle will be in his current postdoc or what my income might be in the fall. Kyle said that he would be fine accounting for some of my irregular income in the fall – basically doing a combo of lump sum and DCA for the Roth contributions from my remaining two paychecks – but I really am not confident yet that I’ll earn anything!
Aaaaanyway, that was what we argued over. We agree 98% what we should do with our money, yet still fight over the remaining 2%! That’s just my personality. 🙂
A few days after our fight I volunteered to yield to Kyle’s wishes, even though I still disagree with him about prioritizing DCA over everything else. The compromise that I got was that Kyle would set up a recurring contribution of 15% of his gross pay from this month forward. I will set up a recurring payment to my Roth of my two months of contributions smoothed over five, plus do the manual contributions for our additional irregular income. At least that way, we won’t have to alter Kyle’s recurring contribution after this smoothing period ends until he changes jobs. Kyle’s happy and I don’t mind this solution too much because I do like DCA. I’ll just have to mess up his plan by earning a bunch of money in the fall. 🙂
What are your opinions on dollar-cost averaging and lump sum investing? How quickly do you update your recurring transactions after an income change?
photo from Free Digital Photos
Filed under: budgeting, retirement · Tags: dollar-cost averaging, lump sum investing, percentage-based budgeting
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I do agree that we base our saving decisions in our past. It gives us a clear and secured basis in how much we can allocate to save rather than just speculating on what probably might happen in the future. Moreover, I just want to appreciate the fact that you submit to the position of your husband and meet a certain understanding on your saving decisions. 🙂
Thanks! It really wasn’t worth continuing to fight about since neither proposal was bad. I recently gave someone the advice to “serve your spouse” whenever possible so I decided I should put my money where my mouth is.
I agree with your position.
I’d also in general recommend to people that they “front load” their 401k contributions to the beginning of the year, so long as it doesn’t affect how much match they get, because putting money into the market now is statistically better than later. However, with that comes the risk of possibly switching jobs during the year to a new employer with a better match. If somebody has a generous match though, this risk is mitigated.
After an income change, I’d change my transactions immediately (by the way, do you use Vanguard’s direct deposit service? It’s amazing. If your employer will allow you to split your paycheck across several bank accounts, you can have part of your paycheck direct deposited to Vanguard, with a fund allocation of your choosing).
I probably wouldn’t take things so far as to front-load a hypothetical 401(k), though I understand your reasoning. Of course it depends if you have the funds available earlier in the year and what you’re going to do with the non-saved portion later in the year. Like I said I’m just really into saving etc. month-by-month instead of over a year or whatever.
I admit we’re a little slow on updating all our transactions this month as we’ve been so busy! Though I wish we had taken care of it right at the start of August.
I haven’t used Vanguard’s direct deposit but it sounds great. I don’t know if our university allows us to split paychecks – considering that they failed to even set up a direct deposit for me despite multiple reminders when I last changed payroll systems, I rather doubt it! I don’t think Kyle would go for making a contribution only once per month, though. It took a LOT of convincing for me to get him away from weekly contributions to move to each of us contributing bi-monthly on alternating weeks – as I said he’s REALLY into DCA. 🙂
I don’t have any recurring savings transactions set up! I get paid at the end of the month, so whatever money I don’t need for the following month’s budget gets transferred to the mortgage around pay day manually. I prefer doing it this way since my direct deposit seems to change a lot of months and my expenses are going to go down a bit in the coming months with my boyfriend moving in 🙂
I always put the full amount into my Roth IRA all at once, either in January or near the end of the year. It’s still dollar cost averaging because you’re putting in ~$5,500/year each year for decades 😉
Leigh recently posted..I might keep my Barclaycard Arrival
I think if you can trust yourself to make the irregular transactions that method will work well. I’ve had enough months in the last year that I’ve been absentminded that I’m glad to have as many things automated as possible!
I didn’t realize your BF was moving into your place. Are you planning to post about how you’ll split expenses and how you’re calculating rent or did I miss it? I’m always interested in the logistical arrangements people come to.
That’s true that you can consider many different time periods for DCAing! I hadn’t though about it on a year-to-year basis but as long as you’re doing it at the same time and aren’t trying to time the market it is DCAing.
Yes! He is moving in officially in the next couple months! It is very exciting!! 😀
I will post something probably, but I’ve been trying to decide what to say without disclosing anything about his finances. Spoiler: I don’t like the words “rent” or “landlord”, so he won’t be paying me rent, but we will both be contributing and I will continue to own the condo in full. This is a serious, long-term relationship after all.
Leigh recently posted..I might keep my Barclaycard Arrival
You two are sooo close to each other – it’s funny when you haggle over the small details. I think that it really doesn’t make any difference honestly. If you didn’t know your job was about to end, you wouldn’t be dollar-cost averaging – it’s just because you know when your money is stopping. Personally, I think I’d just throw it all in like normal (like you) rather than breaking it up over 5 months.
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I don’t think it makes much of a difference either – a few tens or hundreds of dollars on the contributions, probably a few dollars or tens on the difference because of the timing. Definitely not worth a protracted disagreement.
I do the dollar cost averaging. Every month I add enough so that by the end of the year I’ve reached my max on the ROTH. You guys are in pretty good shape if you’re arguing about how to maximize your earnings.
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I agree we’re in good shape if this is the financial topic we’re arguing over. I also like that we both care enough to defend our positions! Great job maxing out your Roth IRA yearly! I hope to get there soon.
Walter Updegrave agrees with you, though sadly none of his articles are available online since he retired. 🙁
Historically (and this is not something Updegrave recommends), if you’re trying to time the markets, you put as much money in as you can in the fall and take out money if you need to take money out before summer starts. It doesn’t work every year, but on average that gets slightly higher returns than dollar-cost averaging. IIRC from a grad finance class.
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Sounds complicated! I’ll stick with DCAing as it’s low-maintenance. I’m all about easy practical solutions that get you nearly all the same results as a complicated method.
It’s really not complicated. It just says to, for example, fund your IRA in September or October instead of May or June.
Updegrave’s argument, otoh, is that the gains you miss out from trying to dollar-cost average outweigh the risk you save from dollar-cost averaging. Especially when you add in purchasing fees. So put lump sums in when you have them rather than holding onto it.
But no, it probably isn’t that big a deal so long as you’re investing at all.
nicoleandmaggie recently posted..And then there were four kitties
I update my recurring transfers immediately after a change in income, it’s just the way I am wired.
As for the whole lump sum/DCA issue, the most important thing is to just invest the money. I think you should focus on that and each of you can use whatever method you feel most comfortable with to get there. At the end of the day, I doubt it make a difference in the long run.
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We were really arguing over a few tens of dollars so that was very silly! It was only a small compromise on my part to go with what Kyle wanted.
Haha at least you’re arguing about what to do with extra money and budgeting whereas most couple’s money arguments are about extreme spending etc!
Gotta keep it in perspective – I have it pretty good!
Remember you are both married to each other, not to personal finance rules of thumb! 🙂
S. B. recently posted..Coming of Age
Great point! The marriage has to come before the trivial principles.
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