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

Episode Summary

Executive Summary: Episode 101 covers site updates, recommended pre-reads, current macro and market news, a rapid-fire Q&A on leverage, factor investing, and the episode’s main research topic: dollar-cost averaging vs. lump-sum investing. The hosts conclude that lump-sum investing usually wins, even in expensive or bearish markets, though DCA can reduce regret and improve behavior for anxious investors.

Main Topics: Website and community updates: The hosts discuss the new Commento-based discussion feature on the Rational Reminder site, how comments are threaded, the possibility of advisors joining discussions, and upcoming site additions like model portfolios and a book list. Recommended reading and upcoming guests: They highlight Brian Portnoy’s Geometry of Wealth and Fred Vettese’s The Essential Retirement Guide as useful preparation for future guest interviews. Macro/current events: CDIC, trading volumes, inflation, QE: They cover CDIC rule changes, a TD Ameritrade trading-volume surge after commissions went to zero, and a nuanced explanation of why QE and fiscal stimulus do not mechanically imply inflation. Rapid-fire factor investing and ETF questions: Questions cover leveraged ETFs vs borrowing to invest, the size factor’s weak theoretical support, a hypothetical 100% small-cap-value portfolio, and why profitability ETFs should be used in combination with value rather than separately. Main research topic: lump sum vs dollar-cost averaging: A detailed data analysis across multiple countries and scenarios shows lump sum investing beats DCA most of the time, with DCA mainly serving as behavioral insurance against regret and extreme bad outcomes. Retirement planning after COVID-19 and annuitization: They discuss how the pandemic may alter retirement behavior, debt reduction, and demand for guaranteed income, including a technical explanation of why mortality shocks can increase longevity risk and the economic appeal of annuities. Bad advice of the week: active management in volatile markets: A Barron’s article suggesting active management is suddenly attractive is criticized as market-timing by emotion rather than evidence; the hosts reinforce that fees and persistence data still favor passive investing.

Key Arguments: New site comments are working well because they are threaded, sorted, and already producing peer-to-peer answers, though organization may become messy over time. Model portfolios are being revised, but a new explanatory paper will accompany them because the changes are substantial. CDIC now covers foreign-currency deposits and term deposits longer than five years, still subject to the existing $100,000 limit per depositor/entity. Quantitative easing is not “helicopter money”; it mainly swaps assets and changes term structure, so inflation does not mechanically follow from money creation. Leveraged ETFs are designed for daily leverage, so compounding and volatility create decay over time, especially in volatile markets. The size effect is weakly supported and may reflect data issues such as delisting bias rather than a clean independent premium. A 100% small-cap-value portfolio is plausible for some investors, but it entails heavy tracking error and deep drawdowns. Profitability should not usually be added as a standalone ETF beside value because it can neutralize the intended factor tilts and push the portfolio back toward market-like exposure. Across countries and time periods, lump sum investing beats 12-month DCA roughly two-thirds of the time over 10-year horizons. DCA is best viewed as regret reduction/behavioral insurance, not as a strategy expected to improve long-run returns. Even in bear markets or when valuations are high, lump sum often still wins; high valuations do not reliably justify DCA. COVID-19 may increase interest in retirement income products because people value certainty, and mortality shocks can raise longevity risk even when life expectancy falls. The article praising active management in volatile markets is presented as a classic example of performance-chasing and weak market timing logic.

Data Points: Podcast episode: 101 - Rational Reminder episode number introduced at the start. Model portfolio target timing: ~2 weeks (around June 18–20) - Benjamin says the new model portfolios and explanatory paper should be discussed/published in about two weeks. CDIC coverage limit: $100,000 - Foreign-currency deposits and other insured deposits remain covered up to this limit per depositor/entity. TD Ameritrade trades/day before zero commission: 800,000 to 1,000,000 - Average daily trading volume before commissions were eliminated. TD Ameritrade trades/day after zero commission: 3,000,000 - Average daily trading volume after trading became free. Bank of Canada policy rate: 0.25% - Rates were slashed three times as part of the COVID response. Canada inflation: Negative in April - Inflation turned negative for the first time in almost a decade. Leveraged ETF example: 2x exposure - Used to explain daily reset and compounding/decay mechanics. Rolling 10-year periods (U.S.): 1,013 - Number of U.S. 10-year rolling windows used in the DCA vs lump-sum study. Rolling 10-year periods (Canada): 652 - Number of Canadian windows used in the DCA vs lump-sum study. Rolling 10-year periods (most series): 485 - Most other country series ran from 1970 to April 2020. Countries analyzed for DCA study: 6 - Australia, Canada, Germany, Japan, United Kingdom, United States. Lump sum wins over DCA (Australia): 61.86% - 10-year rolling periods. Lump sum wins over DCA (Canada): 66% - 10-year rolling periods. Lump sum wins over DCA (Germany): 65% - 10-year rolling periods. Lump sum wins over DCA (Japan): 57% - 10-year rolling periods; weakest among the six countries. Lump sum wins over DCA (United Kingdom): 68% - 10-year rolling periods. Lump sum wins over DCA (United States): 70.6% - 10-year rolling periods. Equal-weighted lump sum win rate: 65% - Average across the six countries; roughly two-thirds of the time. Average annualized performance gap: 38 bps - Lump sum outperformed DCA on average across all markets over 10-year horizons. Worst lump-sum vs DCA differential (U.S.): -6.18% annualized - Starting September 1931; DCA strongly outperformed lump sum in that specific case. Worst lump-sum annualized return in that case: 3.53% - U.S. lump sum return starting September 1931. DCA annualized return in that case: 9.72% - U.S. DCA return starting September 1931. Worst 10% of lump-sum periods: cases where lump sum still won: 51.41% - Within the worst 10% of lump-sum outcomes, lump sum still beat DCA slightly more than half the time. Worst 10% of lump-sum periods: average gap: -29 bps - DCA had a small average advantage in those intentionally selected bad lump-sum periods. Bear market subset: lump sum wins: 53.66% - After a 20%+ drop, lump sum still beat DCA slightly more often across markets. Bear market subset: average gap: 25 bps - Average annualized advantage to lump sum after 20%+ declines. High-valuation subset (initial, forward-looking bias present): 54.24% lump sum win rate - Using U.S. Shiller CAPE in the 95th percentile with full-sample valuation cutoff. High-valuation subset (bias-corrected): 64% lump sum win rate - Using only backward-looking valuation data to avoid look-ahead bias. High-valuation subset (bias-corrected) average gap: 18 bps - Lump sum still outperformed DCA on average in expensive markets. Japan Shiller CAPE peak cited: 44.31 - May 1986, above the U.S. tech-bubble benchmark. U.S. Shiller CAPE peak cited: 44.19 - December 1999; used as benchmark for comparison with Japan. Life expectancy example under mortality shock: 20.11 years to 15.56 years - Example for a 65-year-old under a 60% mortality shock. Longevity-risk coefficient of variation: 45.3% to 51.1% - Mortality shock increases the relative uncertainty of remaining life.

Pivotal Quotes: "The main thing is just keep learning, reading, listening to podcasts to get your own belief system." — Benjamin Felix: Discussion of books, learning, and how people form investing frameworks. "So, dollar cost averaging is basically expensive insurance against a really unlikely bad outcome." — Benjamin Felix: Summary of the DCA versus lump sum analysis after reviewing the distribution of outcomes. "There is no cerebral cortex to a passive approach." — Quoted in the Barron’s article and critiqued by the hosts: Used as an example of weak reasoning behind moving from passive to active management during market stress.

Implications: For most investors, lump sum investing is statistically superior, but DCA can be a useful behavioral tool if regret risk would otherwise cause poor decisions. The episode reinforces evidence-based investing, careful factor use, and skepticism toward emotionally driven active-management shifts.