Surviving a Down Market by Dollar Cost Averaging

When you receive that quarterly statement from your investment company do you feel a pang in the pit of your stomach? Many people are suffering from what I call short term "itis" when they review their IRA statements with the current economic conditions we are facing. If you are at least 10 years away from retirement age it's important to remember the importance of systematic investing in order to take advantage of the highs and lows of the market.

It's an easy concept for those of us who love to shop. Do you go to the mall for the hottest sale? Well you probably realize that if you're there a few days before a holiday vs. the days following, the item you want will be most expensive before the holiday and "on sale" after it's over. If we had a crystal ball or "sales flyer" from our favorite mutual fund it would be super easy to buy low and sell high but unfortunately the next best thing we can do to hit some of the sales is to systematically invest on a monthly basis. Many companies allow you to get started for as little as $25.00 a month and that adds up to $300 a year that you probably won't miss if you cut out a few lattes or manicures. By systematically investing you have a better chance of buying shares at different price points. If you have $25.00 a month and the share price is $5.00 then you can buy 5 shares a month. If one month the share price drops to a dollar you can buy 5x as many shares. When the stock price rebounds you now own more shares at the recovered price.

An example can be found at About.com's article "Investing for Beginners." It states: "You have $15,000 you want to invest in Sprint FON common stock. The date is January 1, 2000. You have two options: you can invest the money as a lump sum now, walk away and forget about it, or you can set up a dollar cost averaging plan and ease your way into the stock. You opt for the latter and decide to invest $1,250 each quarter for three years. (See chart for math of dollar cost averaging plan.)

Had you invested your $15,000 in January 2000, you would have purchased 264.46 shares at $56.72 each. When the stock closed for the year in December of 2002 at $13.69, your holdings would only be worth $3,620!

Had you dollar cost averaged into the stock over the past three years, however, you would own 746.21 shares; at the closing price, this gives your holdings a market value of $10,216. Although still a loss, Sprint FON stock must only go up to $20.10 for you to break even, not $56.72, which would have been required without the dollar cost averaging.

To go a step further, without dollar cost averaging you would break even at $56.72. With dollar cost averaging, you would have turned a profit of $27,326 when the stock hit that price thanks to your lower cost basis ($56.72 sell price - $20.10 average cost basis = $36.62 profit x 746.21 shares = $27,326 total profit.)"

It's critical to find a good mutual fund company, use a tax deferred vehicle such as the Roth IRA and set up your systematic investments so you can begin to see the power of this strategy. The time value of money is your most important weapon so don't delay in getting started. Give yourself the ultimate gift this holiday by setting up your account now.