Dollar Cost Averaging By Larry Lane for InvestorZoo.

com In the investment world, there are many types of risk. Volatility will cause your investments to rise and fall in value. How you manage that volatility will determine whether you will be an investment winner or loser. Before investing in a stock, mutual fund or ETF, there are several factors to consider. How would you react if your investment went down 25% in 6 months? What about if you suffered a 50% loss? Not a pleasant thought, but these are the unfortunate realities of investing. There is no free lunch. Investors in Long Term Capital Management will attest to this. Initially successful with annualized returns of over 40% (after fees) in its first couple of years, in 1998 LTC lost $4.6 billion in less than four months when Russia defaulted on its loans. Long Term Capital consisted of 1994 John Meriweather, the former vice-chairman and head of bond trading at Salomon Brothers. Board of director members included Myron Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences. The most brilliant of economic minds failed because they didn’t properly plan for the risk that the market will inevitability presents. Yes, even a country defaulting on its debt can happen. One of the attitudes one should use when they invest is “what would happen if this part of my portfolio went to 0?” Think of that for a second. Are you overly allocated in one market segment or stock? Have you been at the same company, investing money for the last 20 years in your company’s stock? Does this now make up 2050% or more? The employees of Bear Sterns, Lehman Brothers and others who are improperly allocated will feel the sting of this recession/depression for years and possibly decades to come. The prospect of coming back from a 50% loss will mean your investment must double just to break even. For most investors who are not pouring over charts, reading over k-10 reports and glued to their television 24 hours a day watching CNBC for breaking earnings reports, diversification is paramount. No investment is risk free. The economy, interest rates, wars, terrorism and a myriad of other factors will affect your investments. The key to staying in the investment game is staying invested long term and properly allocated. Invest in all internet stocks and you would have seen a huge drawdown in your portfolio. Stay “conservative” in bonds and you’ll lose significantly when interest rates go up. Want to invest in commodities? Oil went from $147 to $40 in a heartbeat last year. If you had too much money invested in oil, you may have done something very foolish along the way like sell at the absolute low and the absolute worst time. If you had just 5% invested in oil or better yet a basket of commodities (this can be purchased via an ETF or mutual fund), you probably slept pretty well.

A good financial advisor will not recommend a stock or investment to a client because he got a hot tip or because it “feels right”. A financial advisor will probably not find you the next Google, but will construct a complete portfolio consisting of assets from many investment classes. For every 1 successful full time day trader, there are dozens or 100s that have blown their account up and now have nothing. There are simply too many variables to consider. Slippage (the spread between the bid and ask price), commissions and oh yes, you have to be correct more than 50% of the time using money management skills. Invest long term and properly diversify your portfolio and you can be wrong, dead wrong a lot. In fact by dollar cost averaging you can wrong for years and come out ahead.

For the example, assume you put in $100 per month into Fund X: Month 1 2 3 4 5 6 7 8 9 10 Amount Invested $100 100 100 100 100 100 100 100 100 100 Share Price $50 75 100 66.66 40 25 33.33 66.66 80 80 Number Purchased 2 1.33 1 1.5 2.5 4 3 1.5 1.25 1.25

Total $1,000 19.41 Shares Dollar cost Average/Monthly Investing = How much the shares cost divided by how many shares purchased = $1,000/19.41= $51.52. Despite the fact that fund X was extremely volatile, you did pretty well. Your true cost is $51.52 and the fund is now trading at $80! What you’ve accomplished is buying more shares when they are on sale and less when they are higher. This is a good acumen of any good investor. You didn’t even have to stay up late at night worrying that some financial pundit just downgraded your stock or sector. While this is a hypothetical dollar cost scenario, hopefully the illustration above exemplifies the importance of dollar cost averaging and investing long term. If you don’t have a lump sum to invest, dollar cost averaging makes investment sense for most investors.

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