How to Buy in a Volatile Market
“The only person wise about the future is the person who keeps silent.” John Kenneth Galbraith
We talk a lot about the volatility of the market and the uncertainty that wild price fluctuation brings, but I think it's safe to say that our idea of volatility has changed since the events of September 11, 2001. We have seen increased volatility not only in the market, but also certainly in the living of our daily lives. Each one of us will have to find our own way to deal with the changes we encounter in our daily lives, but there are already some tried and true ways to deal with market fluctuations.
Averaging
The Dow dropped some 1400 points in the week following the destruction of the World Trade Center Towers in New York. And since that time the market has seen price swings in both directions. One strategy for accumulating shares and reducing the impact of security price fluctuations is to “average” your position. By buying shares at different times, the investor accumulates the shares at different prices. In other words, I am talking about the systematic purchase of mutual fund shares.
There are basically three different methods of averaging I would like to discuss: (1) dollar cost averaging, (2) share averaging and (3) averaging down.
Dollar Cost Averaging
Under the dollar cost averaging approach, the investor decides to buy additional shares of a stock at regular intervals. For example, you may elect to buy $2,000 worth of mutual fund shares every quarter or every month. You purchase these shares at the appropriate interval, no matter what the price of the stock is. Since the dollar amount of your purchase is the same every time, this technique is known as dollar cost averaging.
The great attraction, of course, of this method is that you automatically purchase more shares of the fund when the price is low, and conversely, fewer shares when the price is high. Thus, over a given period of time, your total average cost is lower.
If the price of the fund shares subsequently rises, you will earn more profits on the lower priced shares and thus will increase the return on the entire position.
Share Averaging
Share averaging is similar to dollar cost averaging; however, instead of periodically buying the same dollar amount, you periodically purchase the same number of shares. For instance, you may decide to buy 25 shares of a fund every month regardless of the price. When the price is low, you are spending less money for those 25 shares and when the price increases, you are spending more for the same number of shares. But, you are accumulating more and more shares over time.
Averaging Down
Some investors find it difficult to purchase shares periodically, especially if the price of the security has increased. Instead, they prefer to purchase additional shares only if the price declines. This is called averaging down. By averaging down, an investor reduces the cost basis of an investment by buying more shares as the price declines so that the average cost of the entire position in the security is reduced.
Your Opportunity
By following one of the above-mentioned approaches, an investor can mitigate the effects of a falling (Bear) market and enhance his or her return when the market rebounds.
For instance, every investor with earned income can contribute up to $2,000 a year to his or her IRA. And, that amount increases to $3,000 next year and so on, until the contribution amount becomes $5,000.
Have you made your contribution yet for this year? Would an averaging type approach help you? Hopefully, the answer to the first question is—yes. And the answer to the second question is—certainly.
Invitation
If you’re not a client yet, and you’d like to explore the option of developing a professionally managed investment portfolio comprised of no-load mutual funds, please give me a call.
I’d be happy to sit down with you and explain how as a fee-only investment advisor I can assist you in meeting your financial goals.
Marshall Sitarik – CFP
Ph. 407-977-3800