Investment Strategies

Systematic Investment or Dollar Cost Averaging

As more people begin to recognize the benefits of investing in the financial markets, the question often arises of when exactly to begin. Should an investor wait for a market downturn, a type of "buying investments on sale"? Should he or she invest as soon as possible so as not to miss the next possible market boom?

If interested in achieving long term growth of capital, a seasoned financial advisor might recommend a strategy known as "dollar cost averaging," because as many investors have discovered, an undisciplined approach to investing can make portfolios overly sensitive to shifts in market value. The idea behind Dollar Cost Averaging is simple: Instead of trying to time market highs and lows, the investor regularly invests a reasonable amount of money in a simple investment vehicle over a long period of time.

Such a strategy attempts to take market ups and downs out of consideration and turns them to your advantage through discipline. Since the focus of Dollar Cost Averaging is on long-term results, investors should not be overly concerned with whether prevailing market conditions are strong or weak when they begin to invest. Instead, what matters more is that you choose a realistic Dollar Cost Averaging program based on their individual financial situation, begin that program and stick with it.

To illustrate how Dollar Cost Averaging might work to your advantage, let's assume that Joe Investor decides to invest $1000 in a stock every three months. If shares in that stock sell for $10, and no additional charges are involved, the first quarterly investment would purchase one hundred shares. Should the market then fall dramatically, reducing the value of stock shares to $5, the $1000 second quarterly investment would purchase 200 shares. If the market were to rebound and stock shares were to rise to $10 in the third quarter, the next investment would again purchase 100 shares, valued at $10 a piece.

Where would Joe Investor stand after making the purchases outlined above? He would, of course, own 400 shares, purchased for a total investment of $3000, with an ending market price of $10 per mutual fund share. However, the shares would actually be worth more than was paid for them. The total current value is $4000 even though the purchase price was $3000.

If this strategy is viewed from another perspective, you can see that the average cost per stock share of the three quarters involved ($10 plus $5 plus $10, divided by three) would be $8.33. However, The average cost to Joe Investor would have been only $7.50 ($3000 divided by 400 shares).

The ability to stick with the original investment plan regardless of changes in prevailing market conditions is the key to success in Dollar Cost Averaging, and investors should consider their ability to continue investing during periods of low prices. Of course, a profit is not guaranteed and Dollar Cost Averaging will not protect against a loss in declining markets. However, following a Dollar Cost Averaging plan of action may help avoid getting out of the market when it's low and rushing in when it's high. Be sure to check with your financial advisor whether dollar cost averaging can help give you a discipline for success in the financial markets.

With a systematic Investment plan, you invest a fixed amount regularly, usually each month.

Systematic investment plans allow you to:

• Reduce the number of investment decisions you have to make
• Avoid the temptation of trying to time the market
• Transfer funds directly from your bank account at no extra cost automatically depending on plan
• Take advantage of automatic investment plans.

A Christmas club is the classic systematic investment, saving a fixed amount each month towards Christmas. What have you saved towards your retirement?

Systematic Investment plans can produce impressive returns.

This chart is for illustrative purposes only and does not represent actual results of an investors experience with any specific investment.

For some, the easiest way to pursue long term investment goals is by taking small steps early and regularly. Modest monthly investments can grow into meaningful amounts with enough time. Consider starting you quest for financial independence today.

Please note: systematic investing does not guarantee a profit or protect you against loss in a declining market. Investors should consider their financial ability to continue investing through periods of low price levels.

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Value Averaging to Reduce Risk

Many investors are familiar with investing by "Dollar Cost Averaging" which involves investing a fixed dollar amount at specified intervals, whether the market is up or down. Dollar Cost Averaging is a powerful tool to encourage systematic savings. It forces investors to buy more shares when prices are lower and fewer shares when prices are high thereby potentially lowering the average cost per share. Value averaging, like Dollar Cost Averaging, relies on time, rather than timing, to protect the investor from market swings. Under Value averaging, the investor sets a target value for his or her investment at specified periods. Then enough shares are purchased or sold to meet the value target.

Value averaging, unlike Dollar Cost Averaging, results in varying amounts being invested each period. Under Value averaging, the dollar amount invested and shares purchased will be up when prices are down. Conversely, purchases will be smaller, and sales might occur, if prices rise. Value averaging, however, may be compatible with investors who want to invest a fixed dollar amount every period. These investors could, after careful consideration and reading a prospectus, consider a family of mutual funds and deposit any sums not actively invested into the family's money market fund to act as a reserve for future purchases in excess of the fixed amount.

For example, let us say that our investor wants to have a portfolio of $4,000. Under Value averaging, the investor targets a portfolio value of $1,000 for January (the initial investment), $2,000 for April, $3,000 for July and $4,000 for October. The following table summarizes how a Value averaging approach would work (disregarding taxes and transaction costs).

After one year the investor has committed $3,597 to the Value averaging program. Based on the $11.50 price, the investment is worth $4,187 for a 16% pre-tax return. Had the investor adopted a Dollar Cost Averaging approach on a similar schedule he or she would have invested $4,000 in a portfolio worth $4,519 and the pre-tax return would have been 13%.

Value averaging is another powerful tool to encourage systematic savings. Some caveats are in order. First Value averaging requires a more sophisticated investor. Second, transaction costs are a greater factor in Value averaging than Dollar Cost Averaging. Third, since both purchases and sales are possible, taxes must be considered. Fourth, investors are reminded that Dollar Cost Averaging and Value averaging do not assure a profit and do not protect against loss in declining markets. Finally, since they involve continuous investments in securities regardless of fluctuating price levels of such securities, investors should consider their ability to continue purchases through periods of low price levels. Check with your financial advisor about the benefits of Dollar Cost Averaging and Value averaging.

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Your Personal Asset Allocation

Too many individual investors blur the distinction between "saving" and "investing." "Saving" is setting money aside in a secure location for a certain need or desire. "Investing" entails putting money to work towards achieving a financial goal with the possibility of generating return. As an investor, it is of utmost importance to be able to answer certain fundamental questions: Will your current investment portfolio be able to meet both short- and long-term investment objectives? Is your current portfolio correctly geared to your individual level of tolerance for risk?

One sound way to answer these questions is by utilizing Asset Allocation -- a disciplined, objective investment game plan that will help you meet your financial goals. Many financial professionals believe the asset allocation decision is the most important step in the investment process. To be most effective, a personal asset allocation model should be tailored to your particular goals and needs.

A simple Asset Allocation model for an individual investor generally requires a portfolio of assets divided into three categories -- stocks, bonds and cash. Each is assigned a fixed percentage. Based on this strategy, a conservative portfolio would generally contain more bonds and cash than stocks. A more aggressive portfolio might contain a higher percentage of stocks. Since diversification of assets is generally recognized as a reliable way to reduce and manage risk in a portfolio, the mix of assets in your allocation model should reflect your preferred level of risk. Considerations such as current spending requirements, tax implications and inflation-adjusted return may also be addressed through the asset allocation process.

Asset Allocation is flexible and revolves around personal needs. However, professional financial advisors have generally found that investors at various age levels tend to be best served by adopting allocation models that address the needs of their "life-cycle phase". In most cases, the longer your investment time horizon, the more aggressive your investment strategy might be.

For example, investors in their 30s and 40s tend to have several needs and concerns in common (e.g., children, new home, college education, retirement planning). To address these concerns, an Asset Allocation plan that emphasizes stocks is often recommended because they historically have provided superior returns over time. At the other end of the spectrum are investors who are close to or who have entered into retirement. Their goal might include providing enough income to maintain a lifestyle, or growth of their capital to ensure that they do not outlive their assets. For these investors an above-average holding in bonds may be recommended.

Obviously, these are guidelines. When implementing an Asset Allocation strategy, the various percentages allocated to stocks, bonds and cash should be assessed on a personal basis and reassessed annually. Be sure to check with your financial advisor regularly on your asset allocation strategy.

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Take a Sensible Step With a Laddered Portfolio

Does this story sound familiar to you? An investor visited a local bank because his one-year certificate of deposit (CD) had reached maturity. He stepped up to the teller and announced he would like to roll his investment over into a new, one-year CD at the same rate. The teller, amused, tells the investor he is out of luck and then points to a display that lists the bank's current CD rates -- two percentage points lower is now the best the bank can offer.

Investors are often disappointed to find out that the current interest rates are much lower than those of their previous fixed income investments. Fortunately, however, a proven investment technique is readily available to help make the most of an evolving interest rate environment.

Adopting a "Laddered Portfolio" approach allows an investor to minimize the interest rate risk that is associated with large, short-term fixed income investments. In a nutshell, this strategy adopts a longer-range outlook and diversifies the maturity structure of fixed income instruments within a portfolio. This enables the total return of fixed income investments to be less adversely affected by interest rate fluctuations.

Structuring a Laddered Portfolio with investments in successive maturities also allows an investor to achieve more flexible management of fixed income oriented assets. The Laddered Portfolio strategy can help accomplish the following goals:

Here are three ways that laddered fixed income portfolios can help an investor succeed in different interest rate environments:

The large variety of fixed income investments currently available enable an investor to choose and adjust the timing of investments within a portfolio to match current and future income needs. Of course, laddering is just one of many investment approaches. A financial planner or investment professional can help analyze each particular financial situation and adopt a strategy that is best for an investor.

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The Hottest Investment Tips

Have you ever received a really hot investment tip?

How many times has it actually worked out?

"Not-so-hot tips" can throw a kink in your long-term investment approach. Here are some sound tips for the long-term investor: