Why Dollar Cost Averaging is Your Best Friend

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Today’s stocks are so incredibly cheap that the estimated PE ratios are under their historical average, and the market as a whole is already more than 50% cheaper than just one year ago. In just one credit crunch, the market was able to remove 12 years of growth from the stock markets – enabling late savers to catch up quickly on the competition, while setting back retirement hopes for many more people.

Nothing Can be Done Now

Unfortunately, for most investors, there is little recourse after the market has already fallen by 50%. To sell at these levels would be a crime, and there is little reason to lock in these huge losses. For many investors who have to sit on the sidelines and watch as the paper losses rack up by the day, this market climate is anything but soothing.

No Instant Fix, But Keep Investing

At this point in time, the only way to fight back the market is to bring your average cost down…dramatically down. If you’ve been saving for more than 15 years, you know the drill; the market is beaten, but not forever, and the stock market will not cease to exist overnight. Investors who just jumped into the game might be disgruntled by slumping prices on Wall Street, but this is no time to be dumping shares. The stock market’s irrationality has provided the new investor one of the biggest gifts in the world: buying in today is the same as buying in 12 years ago, with the exceptions that incomes have grown since then and so have the annual maximum contributions to retirement funds.

Think Dividends

Some stocks have been unfairly treated in this market, with many quality names sold off with the bad. Since that time, dividends have been minimally changed, except for the financial industry, which continues to cut dividends quarter after quarter. Avoiding the financial industry is the key because many of the banking names to hit the highest yielding lists have all rapidly lowered dividends to keep costs down. Other than the high dividends in finance, some other names are paying incredibly high yields.

Revisiting Dollar Cost Averaging

With the markets as volatile as they are at present, the difference of a few hours could easily be whole percentage points. Many investors choose to invest every week, or every other week as they are paid, which is an excellent way to implement dollar cost averaging – except that it does not average very well. For that reason alone, consider averaging in every x point loss in your favorite index. Purchasing shares over a period of drops, rather than time, will allow you to secure your positions as an actual cost average, rather than a time average. The markets have already showed us that being invested in the long haul does not produce profits (the market just lost 50% in a year); instead, it’s about being in the market at the right price!

Index ETFs: A Perfect Way to Dollar Cost Average

Index ETFs and a good broker are all that is really needed to set up a solid dollar cost average investment scheme. Each week, set a limit order for your chosen value to buy the index. If the market fails to hit that price during the week, double up next week. This is the most important part to dollar cost averaging, but too many people overlook this element. You need to keep adding to your investment pool at the RIGHT price and not at ANY price. Even consider adding one limit order above and one below the current price so that you’ll enter the market more as it bounces. As bounces are indicative of bottoming, you might just take the market to the bank on a turnaround.

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