A PERFORMANCE ANALYSIS OF DOLLAR-COST AVERAGING AND SELF-ANNUITIZATION

Abstract

The return and risk of dollar-cost averaging (DCA) and self-annuitization (SA) investing are compared with the underlying return in this paper. The underlying return, which is assumed to be normally distributed, is generated by Monte Carlo simulations under six market scenarios including upward and mean reverting markets across several investment horizons. Owing to the multiple cash flows of DCA and SA, the annual internal rate of return is used to measure the DCA and SA returns. The results show that the mean return of DCA is slightly higher than the underlying return, while the SA is lower, particularly under short investment horizons. Both DCA and SA produce higher return volatility and riskiness than the underlying return. They also create negative skewness and excess kurtosis for the return distributions. For comparing their performances, we use the economic performance measure which can consider those high moments of distribution. Except for the mean reverting market, the underlying return is the best performer, while SA is the worst. This evidence becomes even clearer and convincing as the investment horizon increases. DCA can have lower riskiness and perform better only under the mean reverting market.