Dollar-Cost Averaging Takes Emotion Out Of Investing - Investors.com

Suppose you went to cash during the 2008 market meltdown.

Or you just inherited a bundle from your rich uncle.

What now?

Should you put the whole kitty back to work in stocks and stock funds all at once? Or should you ease back in a little at a time?

The conventional wisdom says that dollar-cost averaging ? which is the Wall Street name for investing fixed amounts at set intervals ? is better than lump-sum investing.

But your results will depend on how the market behaves during your investment period.

Dollar-cost averaging tends to work best in periods that include declines from the starting point.

Bear in mind that this strategy choice between lump sum and dollar-cost averaging basically applies to mutual funds or other portfolios over time. Investors using a proven individual stock strategy should base trades on the rules of their investment blueprint.

At its best, dollar-cost averaging has powerful benefits. One is that it lowers your average cost. Your fixed investment buys more shares when prices are lower and fewer shares when prices are higher.

Another benefit is that dollar-cost averaging provides a routine that keeps you invested. That's what investors do when they invest a percentage of their paycheck each month in a 401(k) plan.

A third benefit is it prevents novices from trying to time the market.

"Investors tend to lag," said T. Rowe Price senior financial planner Judith Ward. "Once they get out, they wait for things to get better, so they miss a lot of the rebound."

Volatile Market

Sam Stovall, Standard & Poor's chief equity strategist, looked at how the S&P 500 fared over various stretches of the tumultuous market after 2000.

Bottom line: Dollar-cost averaging outperformed if an investor started at or near a market high. Lump-sum investing outperformed off lows.

A lump-sum tack benefits from price gains off a trough. It has a low price that dollar-cost averaging can't beat. It also benefits from owning a lot of dividend-paying stocks from the get-go.

And dollar-cost averaging diversifies your investments over time. If you start near a market high, with dollar-cost averaging you lose less in the ensuing decline.

"If you lose less, you have to make up less to get back to break-even," Stovall said.

When you lose 20%, you need a 25% gain to recoup.

When you lose 40%, you need a 67% rally to break even.

"Also, dollar-cost averaging's psychological benefit is often critical," Stovall said. That's because many investors are choosing between it and staying out of the market, not a lump-sum option.

"Dollar-cost averaging feels safer, so it gets people to invest ? which is good," Ward said.

Which approach should investors use in our current market?

Odds are the market will pull back 5% or more some time this year, Stovall says, since that's happened every year since World War II. That means we're probably near a short-term high.

"So if you're trying to decide how to invest a large amount at this point, chances are dollar-cost averaging will be a better way to go," Stovall said.

Source: http://news.investors.com/investing-mutual-funds/042513-653558-how-to-use-dollar-cost-averaging.htm

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