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Introduction
In the dynamic landscape of financial markets, investment strategies have evolved to offer a multitude of options for traders and investors alike. With sophisticated algorithms and high-frequency trading platforms taking center stage, there's a growing curiosity to evaluate and understand the performance of traditional strategies.
One such age-old debate pits two of the most commonly adopted methods against each other: Buy and Hold vs Dollar-Cost Averaging. While the former emphasizes the long-term holding of assets, the latter stresses the importance of mitigating market risks through consistent, periodic investment. In this comprehensive case study, we delve into the nuances of these two approaches to assess their viability over a medium-term investment horizon. Through rigorous analysis and empirical evidence, this article aims to equip you with the insights needed to make informed investment decisions.
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Experiment
A Five Year Retroactive analysis
In this experiment, we aim to unravel the long-standing debate between two popular investment strategies: Buy and Hold, and Dollar-Cost Averaging. To set the stage, let's break down the core tenets of each approach.
Buy and Hold Strategy: In this scenario, you receive a substantial sum of money, which you invest entirely in a single stock. Following the investment, you take a hands-off approach and do not touch the stock for the next five years.
Dollar-Cost Averaging Strategy: Though the name might evoke mysticism, the concept is remarkably straightforward. Rather than investing your entire portfolio at once, this strategy entails putting 1% of your portfolio into the chosen stock every four weeks. We'll be assessing the slow-and-steady efficacy of this strategy in comparison to its Buy and Hold counterpart.
Stock Selection Criteria
For a comprehensive evaluation, we selected 3 diverse stocks:
- SPY (+51% for the Past 5 Years): Often considered the gold standard of ETFs, SPY is renowned for its steady yet significant growth.
- NVDA (+555% for the Past 5 Years): A high-growth tech powerhouse, whose performance has been nothing short of stratospheric.
- T (-38% for the Past 5 Years): A currently underperforming stock in the communications sector, offering a glimpse into how these strategies fare with lagging assets.
The selection aims to provide a balanced perspective by incorporating a growth champion, an underperformer, and a stable grower. While the experiment may not cover all the nuances, it aims to offer valuable insights into how various types of stocks respond to these investment strategies.
Dividend Disclaimer: It's crucial to note that this experiment focuses solely on capital gains, excluding the impact of dividend reinvestments.
Experimental Setup
We’re going to use NexusTrade’s AI-Powered Chat to create and test these strategies. After creating a free account, we’re going to ask Aurora to do the following:
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Generate 6 different portfolios. All with $10,000. The names are:
Buy and Hold SPY
Buy and Hold NVDA
Buy and Hold T
DCA SPY
DCA NVDA
DCA T
For the buy and hold, the strategies are obvious. Always buy.
For the DCA, the strategies will be
"Buy 1% of your portfolio value in (targetAsset) when the day is Friday
and 28 days passed since the last purchase of (targetAsset)
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With this, wait around a minute for NexusTrade to do its magic, and generate your ideas from plain English. NexusTrade will read your input and generate all of the portfolios we’ll need to evaluate our results.
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Results
Evaluating the results is as easy as sending a text message. Literally.
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Before diving into the conclusions, let’s break down the results. This will be a summary of the results, but you can scroll to the bottom for the raw data to draw your own conclusions. Even though I asked Aurora to do the past 5 years, she created these backtest periods starting on January 1, 2023. She’s not perfect, nobody is.
SPY (S&P 500 Index ETF)
- Buy and Hold: If you invested in SPY five years ago and just held onto it, you’d have seen a 63.72% return on your investment. The strategy achieved a high Sharpe Ratio of 2.36 and a Sortino Ratio of 2.78, suggesting good returns for the level of risk taken. However, the strategy wasn’t without its drawbacks; it had a maximum drawdown of 34.09% and an average drawdown of 6.86%.
- Dollar-Cost Averaging (DCA): Taking the DCA approach yielded a 21.78% return over the same period — considerably less than Buy and Hold. However, it came with less risk, with a max drawdown of 19.07% and an average drawdown of 3.26%.
NVDA (NVIDIA Corporation)
- Buy and Hold: This tech stock was a windfall for those who chose the Buy and Hold strategy, bringing in a jaw-dropping 762.14%% return. The Sharpe and Sortino Ratios were exceptionally high at 4.37 and 6.03, respectively. But the rollercoaster came with deep valleys — a max drawdown of 67.26% and an average drawdown of 21.64%.
- Dollar-Cost Averaging (DCA): Those who opted for DCA with NVDA still experienced robust growth of 329.12%, though not as astronomical as the Buy and Hold. The risk-adjusted metrics were also strong, with Sharpe and Sortino Ratios at 3.95 and 5.41, respectively. Interestingly, DCA had a slightly lower max drawdown at 63.39% but significantly lower average drawdown at 11.34%.
T (AT&T Inc.)
- Buy and Hold: Investors who adopted a Buy and Hold strategy with T would’ve faced a decline of 47.21% in their portfolio value. Risk metrics here are in the negative, with Sharpe at -1.43 and Sortino at -1.69. Additionally, the strategy saw a maximum drawdown of 55.00% and an average drawdown of 25.89%.
- Dollar-Cost Averaging (DCA): Choosing DCA for T would’ve still resulted in a loss but a significantly reduced one at 20.04%. Even though Sharpe and Sortino ratios remained negative at -1.59 and -1.76, the max and average drawdowns were far less severe at 30.13% and 8.35%, respectively.
Conclusion
So, what do these numbers tell us?
- Profitability: The Buy and Hold strategy outperformed Dollar-Cost Averaging in terms of overall percent change for both SPY and NVDA. Interestingly, even in the case of a losing stock like T, DCA managed to lose less.
- Risk: Both Sharpe and Sortino Ratios were generally higher for Buy and Hold, indicating better risk-adjusted returns. However, it’s worth noting that DCA had a significantly lower maximum and average drawdown in all cases.
- Volatility: Buy and Hold presented higher volatility and risks, as indicated by the maximum and average drawdown. In volatile markets or for risk-averse investors, DCA could be a safer bet.
To sum up, if you’re looking for raw growth and can tolerate the associated risks, Buy and Hold is your go-to strategy. On the other hand, if you’re seeking a less volatile investment path with a safety cushion against downswings, Dollar-Cost Averaging might be your cup of tea.
No strategy is universally better; it all boils down to your individual risk tolerance, investment horizon, and financial goals. So the next time you find yourself in a debate over investment strategies, you’ll have more than just an opinion — you’ll have the facts.
There you have it! If you’ve made it this far, you’re likely as excited about these findings as we are. Feel free to connect on LinkedIn, Instagram, and TikTok for more in-depth financial discussions. Here’s to making informed investment choices!
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Raw Results
If you want to see the raw numbers without creating an account on NexusTrade, then look below.
SPY
Buy and Hold
- Percent Change: 63.72%
- Sharpe Ratio: 2.36
- Sortino Ratio: 2.78
- Max Drawdown: 34.09%
- Average Drawdown: 6.86%
Dollat-Cost Averaging (DCA)
- Percent Change: 21.78%
- Sharpe Ratio: 1.84
- Sortino Ratio: 2.17
- Max Drawdown: 19.07%
- Average Drawdown: 3.26%
NVDA
Buy and Hold
- Percent Change: 762.14%
- Sharpe Ratio: 4.37
- Sortino Ratio: 6.03
- Max Drawdown: 67.26%
- Average Drawdown: 21.64%
Dollar-Cost Averaging (DCA)
- Percent Change: 329.12%
- Sharpe Ratio: 3.95
- Sortino Ratio: 5.41
- Max Drawdown: 63.39%
- Average Drawdown: 11.34%
T
Buy and Hold
- Percent Change: -47.21%
- Sharpe Ratio: -1.43
- Sortino Ratio: -1.69
- Max Drawdown: 55.00%
- Average Drawdown: 25.89%
Dollar-Cost Averaging (DCA)
- Percent Change: -20.04%
- Sharpe Ratio: -1.59
- Sortino Ratio: -1.76
- Max Drawdown: 30.13%
- Average Drawdown: 8.35%
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