Switch payment to a risk-free deposit account

By John Mingers, Kim T Parker. European Journal of Operational Research. Amsterdam: Nov 16, 2010. Vol. 207, Iss. 1; pg. 508

Many people invest regularly in sinking funds that track stock market indices. When stock markets themselves sink significantly, as in the current credit crunch, investors face a decision as to whether they should continue paying into a falling fund, or switch payment to a risk-free deposit account until the market recovers. Most financial advice is to keep investing on the grounds that as the unit price falls more units can be purchased and that this is ultimately beneficial (dollar-cost averaging, DCA). However, most academic studies show that DCA is suboptimal, at least to a lump sum strategy. In this paper, the authors consider a specific, tax-free fund – the Individual Savings Account (ISA). The authors demonstrate, both analytically and numerically, that in a situation of perfect information a stop and restart policy can beat DCA. From these results the authors test some heuristics that could be used by an everyday investor under real-world conditions of uncertainty and volatility.

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