Factor Nuances, Dollar Cost Averaging, and Annuities in a Pandemic (EP.101)

Episode Summary

Executive Summary: In episode 101 of the Rational Reminder Podcast, hosts Benjamin Felix and Cameron Passmore discuss the new discussion board on their website, announce upcoming guests and book recommendations, and analyze listener questions on leveraged ETFs, small-cap value investing, and factor implementation. The main topic is Ben's comprehensive paper on dollar cost averaging versus lump-sum investing, concluding that lump-sum beats dollar-cost averaging about two-thirds of the time across multiple markets. They also cover financial planning implications of the pandemic, including the increased relevance of annuities, and deliver a 'bad advice of the week' segment warning against active management in turbulent markets.

Main Topics: Website Discussion Board & Housekeeping (Priority: 2/5): Introduction of Commento app for comments on the Rational Reminder website, plans to involve other advisors, and upcoming publication of a curated book list. Dollar Cost Averaging vs. Lump Sum Investing (Priority: 5/5): Ben presents his in-depth paper analyzing rolling 10-year periods across six countries. Lump sum beat dollar cost averaging ~2/3 of the time, with an average annualized cost of 0.38% for DCA. Even in bear markets or when stocks are expensive, lump sum tends to outperform. Leveraged ETFs & Decay (Priority: 3/5): Explanation of daily rebalancing causing 'path dependence' or decay, especially in volatile markets. Conclusion: leveraged ETFs are generally inferior to homemade leverage for long-term investors. Size Factor and Profitability Factor (Priority: 4/5): Discussion on whether size is an independent risk factor (deemed weak), and why profitability and value should be combined in a multi-factor approach rather than used separately to avoid neutralizing factor exposures. Pandemic's Impact on Retirement Planning (Alexandra Macqueen's article) (Priority: 3/5): Three predicted fallouts: reduced early retirement, increased debt reduction, and rising appeal of guaranteed income (annuities, CPP, OAS). Mortality Shocks & Longevity Risk (Moszé Milevsky's article) (Priority: 3/5): Counterintuitive finding that a mortality spike increases longevity risk (coefficient of variation), making annuities more valuable despite lower life expectancy. Bad Advice of the Week: Active Management in Weird Markets (Priority: 2/5): Citing a Barron's article urging advisors to go active. Ben and Cameron refute this with evidence that active management underperforms, and fees benefit the manager, not the client.

Key Arguments: Lump sum investing outperforms dollar cost averaging ~65% of the time across developed markets, implying an expected annual cost of 0.38% for DCA. Leveraged ETFs suffer from volatility decay due to daily rebalancing; homemade leverage is superior for long-term investors. Size premium is empirically and theoretically weak; combining value with profitability in a multi-factor approach is more effective than using separate factor ETFs. Mortality spikes increase longevity risk (higher coefficient of variation of remaining life), making annuities economically more valuable despite lower life expectancy. Active management's success before fees accrues to managers, not clients, as highlighted by Ken French's research.

Data Points: Lump sum beats DCA percentage (US): 70.6% - Over rolling 10-year periods from 1970 to 2020 Average annualized cost of DCA: 0.38% - Equal-weighted average across six developed markets Lump sum beats DCA after 20%+ market drop (Canada): 78.57% - Historical data across all markets examined Lump sum beats DCA when Shiller CAPE at 95th percentile (backward-looking): 64% - US data corrected for look-ahead bias Coefficient of variation for 65-year-old: normal vs. 60% mortality shock: 45.3% increases to 51.1% - Illustrates increase in longevity risk despite lower life expectancy Active managers beating benchmarks in 2020 V-shaped recovery: 48% - Counterpoint to claims that active management outperforms in volatile markets

Pivotal Quotes: "If you're investing in a portfolio that is so scary that you feel the need to dollar cost average, maybe that's not an appropriate portfolio." — Benjamin Felix: Summarizing the behavioral finance implication of preferring DCA over lump sum "Longevity risk is not that you might live a long time. Rather, it's the uncertainty around that expectation." — Cameron Passmore (paraphrasing Moshe Milevsky): Explaining how mortality shocks paradoxically increase the economic value of annuities "There is no cerebral cortex to a passive approach." — Financial advisor quoted in Barron's article: Ben used this quote as an example of bad advice, opposing active management during the pandemic

Implications: For investors, the key takeaway is clear: lump-sum investing is statistically superior to dollar-cost averaging for new cash, regardless of market conditions. Planning for retirement should account for increased longevity risk (not just lower life expectancy) and consider annuities as a valuable hedge. Avoid reacting to market volatility by switching to expensive active management.