Benjamin Graham has been credited with many investment inventions over the years, but one of his most understated has to be the process of dollar cost averaging.
That said, it’s difficult to claim that Graham created dollar cost averaging, although he was one of the greatest proponents of the strategy, advocating its use for almost every investor to help achieve the best returns from "Mr. Market."
As well as advocating the use of dollar cost averaging, Graham also regularly recommended the use of investment funds for the average investor as an alternative to single stock investing.
For example, in an interview with US News & World Report dated June 3, 1955, responding to the question of how a man with an income of $5,000 should invest and whether common stocks are suitable, Graham replied:
“On the whole, I would say, ‘No,’ largely because what he could gain by having a common stock component in his savings isn’t significant enough to warrant the amount of intelligence and character needed to carry on an investment program in common stocks soundly.”
He went on to say that a better investment might be fixed income securities even though they may result in a loss of purchasing power over the long term.
And if the low-income investor really wants to get involved in stocks, Graham had some further advice:
"Graham: Perhaps I should correct my previous statement a little bit. It is possible for the small man, the $5,000-a-year man, who wishes to build up an interest in common stocks out of his rather modest savings, to do so reasonably well by following one of those accumulation programs in the investment fund area.
"Interviewer: Investment companies?
"Graham: Yes, investment companies. Yes, he could do it, and I think on balance it would probably be better for him to do it if he wants to do so rather than not do it. There are some risks involved in the program, but there are also some advantages too."
Graham comes across in the interview as against common stocks almost entirely for the majority of the investing population. On more than one occasion he says researching individual securities is not appropriate for the average investor who lacks time, education and intelligence:
"Interviewer: You think the average person is capable of doing this?
"Graham: Well, taking everything into account, I would say no. I mean if you look at a person at random and gave him the ideal surroundings and education and counsel and so on, you might turn into a person capable of doing this. But under the circumstances in which he lives, he probably would not do a good job.
"Interviewer: Who would then?
"Graham: It would be good for a person who has considerable native intelligence and ability and who has a real interest in financial matters and is willing to devote the amount of time and energy to it.
"Interviewer: And who has the time for it –Â the time is necessary?
"Graham: Well, everyone has the time for it. It’s the determination that counts. I mean, investing a few thousand dollars is not a full-time job. But it is a job that you can’t do casually, by tips and so forth."
And what if the average investor wants to benefit from the gains available in the market but does not have the time or intelligence to invest in single stocks and manage his own portfolio? Well, as noted above, Graham recommends investment companies and dollar cost averaging to help smooth out long-term returns:
“I suggest that he buy investment company shares on a regular basis. That brings in the concept of dollar cost averaging. The main thing for him is not to go off suddenly on a tangent, believing that he had suddenly become an expert because the market has gone up, and he has been making some money.”
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"Investing the same amount of money at regular intervals – say, every three months – you get two advantages. One is that over the years your investment reflects the average market price rather than the high market levels – which is where you are likely to buy if you follow the crowd.
"Second, the arithmetic of dollar averaging gives you more shares at the lower prices than at the higher prices so that your average cost is lower than the arithmetic price."
Asked if he believes that this is a sound plan for the individual investor, Graham replied, “Yes, I think it’s the soundest and most simple plan open to everybody that I know of.” He went on to say that this program, while sound and simple, only really works over a 10-year period. The reason why this time frame is the most useful is that it generally takes markets 10 years to recover from a deep bear market. Graham uses 1929 as an example:
“The reason you talk about a 10-year period is that past analysis shows that had you started at any time, even at the top of the market in 1929, you would have done all right by 10 years later.”
