Friday, 28 February 2014
How to be a millionaire? Save regularly and save early.
Dollar Cost Averaging Can Reduce the Risks of Investing in Stocks and Bonds
Dollar cost averaging is not a panacea that eliminates the risk of investing in common stocks.
It will not save your investment plan from a devastating fall in value during a year such as 2008, because no plan can protect you from a punishing bear market.
You must have both the cash and the confidence to continue making the periodic investments even when the sky is the darkest.
No matter how scary the financial news, no matter how difficult it is to see any signs of optimism, you must not interrupt the automatic pilot nature of the program.
Because if you do, you will lose the benefit of buying at least some of your shares after a sharp market decline when they are for sale at low prices.
Dollar cost averaging will give you this bargain. Your average price per share will be lower than the average price at which you bought shares.
Why? Because you will buy more shares at low prices and fewer at high prices.
Some investment advisers are not fans of dollar cost averaging, because the strategy is not optimal if the market does go straight up. (You would have been better off putting all $5,000 into the market at the beginning of the period.).
But it does provide a reasonable insurance policy against poor future stock markets.
And it does minimize the regret that inevitably follows if you were unlucky enough to have put all your money into the stock market during a peak period such as March of 2000 or October of 2007.
There is tremendous potential gains possible from consistently following a dollar-cost averaging program.
Because there is a long-term uptrend in common stock prices, this technique is not necessarily appropriate if you need to invest a lump sum such as a bequest.
If possible, keep a small reserve (in money fund) to take advantage of market declines and buy a few extra shares if the market is down sharply.
Though you should not try to forecast the market, it is usually a good time to buy after the market has fallen out of bed.
Just as hope and greed can sometimes feed on themselves to produce speculative bubbles, so do pessimism and despair react to produce market panics.
The greatest market panics are just as unfounded as the most pathological speculative explosions.
For the stock market as a whole (not for individual stocks), Newton's law has always worked in reverse: What goes down has come back up.
(A Random Walk Down Wall Street, by Burton Malkiel)