The Wisdom of Dollar Cost Averaging

IT NEVER fails. Every time you plunge into the market, you find yourself buying in at the top. Then, stocks stumble and you get so discouraged that you sell precisely at the bottom. You can avoid these expensive errors by investing a set amount of money each month regardless of whether the market is heading up or down. This is a canny and often profitable investment strategy called dollar cost averaging.

Think of it as investing on the installment plan. You regularly invest, say, $50 or $ 100 each month. If stock prices then go up, you can congratulate yourself for having earned some profits. But what if prices go down? Well, you congratulate yourself on your new opportunity to pick up some bargains. Several months ago, your $50 monthly investment could buy, say, only two shares; now it can buy three!

Many people find that a sound way to practice dollar cost averaging is to buy the shares of a mutual fund at regular monthly intervals, particularly a no load mutual fund with a record of having done better than the broad market averages over the last several years. No load mutual funds give you professional management of a diversified portfolio of securities for a small fee.

Dollar cost averaging also can be used to buy shares of individual stocks, but brokerage fees on small transactions can be prohibitively high often at least $30 to $35 a trade. And because mutual funds have diversified portfolios, they tend to bounce back from market disasters when the market ultimately recovers. But an individual stock can fall through the floor and stay in the cellar for years. True enough, if you sink all of your money into the stock market in a lump sum, and then the market proceeds to rise like a rocket and continue climbing for many years, you will do better than if you put in your money bit by bit, month after month. But look at dollar cost averaging as a defensive strategy. It will keep you from getting crushed in the wild up and down market swings. The discipline of investing fixed amounts in regular installments helps you to avoid two common errors: putting all your money into the stock market at a time when it might be getting ready for a sharp tumble, and selling out at big losses when stocks are deeply depressed.