Steady as you go: Can dollar cost averaging beat market timing?

Although consumers react positively to a 25 percent off sale on apparel or sporting goods, the same shoppers flee when the financial market is on sale. "When the market climbs, investors perceive their only risk as not investing fast enough to benefit from certain gains," said Mike Flower of Financial Principles, LLC. "And when the market plummets, the prevalent fear is that stocks will slide even lower." For example, he said, someone who moved into cash in early March, when market sentiment was arguably worse than last summer, would have missed the strong gains of the past few months. Fowler said rather than make misguided attempts to time investments to hit market upswings, perhaps the best approach it to try and control the inevitable volatility. An investment strategy known as dollar cost averaging can be especially effective during a market downturn. What is dollar cost averaging? Dollar-cost averaging involves investing a fixed dollar amount at pre-determined intervals, as is done with a 401(k) plan. Set monthly contributions buy fewer shares when the market is up and more shares when the markets are down, resulting in an average cost per share over time. Today, even the most disciplined investors, fearful that the market will decline further, are questioning whether it's wise to stick with dollar cost averaging and continue to make their regular contributions to 401(k) plans and IRAs. However, studies* have shown that dollar cost averaging may result in better long-term returns than strategies that involve moving in and out of the market, known as "market timing." How does it stack up? A recent Fidelity study, for example, evaluated how various market timing strategies would have compared to simply sticking with a plan to invest $500 each month into an S&P 500 Stock portfolio from January 2000 to January 2004, a period that included the technology bubble and the beginning of the market's recovery*. Fidelity found the "Stay-the-Course Investor," who maintained a dollar-cost averaging approach throughout the period fared better than the "Bear Market Dodger" who shifted 100 percent of new contributions to cash before incurring any losses, and moved 100 percent of new contributions back into stocks as the market resumed a long-term uptrend; the "Bear Market Refugee" who shifted all new contributions to cash at the onset of a bear market (20 percent drop), and 100 percent of new contributions back into stocks as the market resumed a long-term uptrend; and the "Doomsday Capitulator" who shifted 100 percent of new contributions to cash at the bear market's cyclical low point, and 100 percent of new contributions back into stocks as the market resumed a long-term uptrend. "While the discipline of dollar cost averaging should remove emotions from the investing equation, the strategy does not advocate operating on auto-pilot," Flower said. "Especially in this volatile market, you need to review your accounts and rebalance more frequently. If you have moved 401(k) assets to low-risk investments such as Treasury bonds to ride out the market storm, you may want to start moving back into a more aggressive allocation. Moving your assets a little at a time via dollar cost averaging rather than all at once reduces your risk. You might also decide to keep existing assets invested in a conservative fashion to preserve your wealth, but take on more risk with your new regular contributions." A way to get back into the game For those who have retreated entirely to the sidelines, dollar cost averaging could be a lower risk way to get back in to the market. As markets start going back up, investors who keep avoiding stocks will not participate in the gains. However, those who invest a fixed dollar amount every month will be much better positioned to benefit from the market's eventual rebound. "Especially in a recession, dollar cost averaging remains a long-term investing strategy that helps eliminate potentially harmful temptations to time the market," Flower said. "Sure, it's possible that the market will retreat further in the coming months, but in the eyes of a disciplined Dollar Cost Averager, the decline presents an ideal buying opportunity." Article written by Mike Flower, Securities America, Inc. Registered Representative, in conjunction with Marie Swift. Visit www.financialprinciples.com to learn more about the advisors at Financial Principles. *SOURCE:http://www.mfea.com/NewsCommentary/Archived/Commentary/FidelityStrategy_092408.asp Dollar cost averaging involves continuous investment in securities, regardless of the fluctuating price levels. Investors should consider their ability to continue purchases through periods of low price levels or changing economic conditions. However, such a plan does not assure a profit and does not protect against loss in declining markets. AdTrax # 78857