Dollar Cost Averaging vs. Lump Sum Investing

I dollar cost average into lots of stuff. My sharebuilder account (and therefore stock purchases), mutual funds, etc. It's really just a fancy term for setting aside savings each month.

DCA advocates will tell you to dollar cost average everything. If you come into a lump sum, you should spread these purchases out over several months. Honestly, though, you can make up sotck purchase prices to support either side - DCA or lump sum purchases.

Research usually shows that it doesn't matter in the long term; here's the latest research I've seen on the subject.

The bottom line:

1. If you're currently doing dollar cost averaging, that's great. Don't stop.
2. If you have a lump sum to invest, don't worry about dollar cost averaging. Make the purchase with the entire lump sum. DCA and lump sum purchases will give approximately equivalent results.

Overvalued and Undervalued ETFs

I like to buy on the cheap. Problem is, when you're looking at an index fund/ETF, or a sector fund/ETF, there's not always something obvious like a P/E ratio to help you figure out if it's expensive or cheap.

It can be easy: I'd like to add an REIT piece to my portfolio this year, but I doubt anyone thinks REITs are cheap right now.

One of the things I look at for valuations is Morningstar's Fair Value numbers. I think many of these valuation tools are a little "out there", but at least they can give you an idea. Morningstar recently had articles on the valuation of market indexes and some sectors, as compares to their Fair Value, here and here. A login may be required; it just takes an email address and I recommend it.

The market indexes are trading pretty near Morningstar's fair value. The Dow Jones Industrial Average is about 6.9% below it's "fair value" while the S&P 500 is about 3.5% overvalues and the Nasdaq is about 2% overvalued.

As for sectors, Morningstar rates several REITs, including ICF, RWR, IYR, and VNQ, as being overvalued by 23% to 27%. They rate the energy sector as overvalued as well, including IEZ as 47% overvalued!

Morningstar rates several technology ETFs as undervalued, including IGM at 84% of fair value, and IGN at 76% of fair value. Homebuilder ETFs are the most undervalued, including XHB at 73% of fair value and ITB and 67% of fair value .

Investing in Micro-caps

I'm working on a series of posts about various "lazy" portfolios. In the process, I've come across a couple of portfolios that invest in micro-cap stocks. These companies usually have market capitalizations between $50m and $300m or $500m, depending on whom you ask. They're not the absolute smallest stocks - there is a nano-cap category. These small companies are very risky, and these funds can be a roller coaster ride.

What I didn't know is that there's a micro-cap index, and a couple of micro-cap ETFs. Unfortunately, they haven't been around long. I'll compare them to the S&P 500 for performance, and to another micro-cap mutual fund.

iShares Microcap Index (IWC): 0.6% expense ratio. This tracks the Russel Micro-cap index minus the companies who are failing.

Powershares Zack's Micro-cap (PZI): 0.6% expense ratio. This tracks stocks between $60m and $600m. So far ( a little over a year) it's got a 78% turnover ratio! That's going to create some taxable income at the end of the year.

Bridgeway Ultra Small Company Market (BRSIX): 0.65% expense ratio. Performance has topped 99% of its peers, though I'm still working on what those peers are. The fund manager is apparently known for keeping taxable changes to a minimum. The fund has $1.18b in assets. Morningstar even comes out and recommends this fund in the analysis of the 2 ETFs! Note that they only give the fund a 3 star rating, and that lots of analysts think that the multi-year run for small cap performance is coming to an end.

Ticker	Name	2000	2001	2002	2003	2004	2005	2006
SPY	S&P 500 ETF	-9.73	-11.81	-21.54	28.18	10.7	4.83	15.85
IWC	iShares Russel Microcap Index							14.89
PZI	Powershares Zack Microcap							18.03
BRSIX	Bridgeway Ultra-Small Company	0.7	24.0	4.9	79.4	20.1	4.1	11.5

Bond ETFs from Vanguard

Vanguard has created more bond ETFs. At this point, you can use ETFs for the entire portion of your indexed portfolio in bonds.

They are:

BND: Vanguard Total Bond Market Index (note: this one has big competition in AGG. Vanguard's ETF has a 0.11% expense ration vs 0.20% for AGG. Vanguard replicates the whole index, while AGG samples the index.
BSC: Vanguard Short Term Bond
BIV: Vanguard Intermediate Term Bond
BLV: Vanguard Long Term Bond

The only thing really missing here is an inflation-protected bond index like TIP.