Cents and Sensibility
Cents and Sensibility
HAS the stock market become more volatile? It would seem so, considering the 100- and 200-point gains and losses that have occurred with regularity in recent weeks. But appearances can be deceiving. Systematic investing
guards against volatilityIt's important to keep in mind that a 200-point gain or loss is actually not that significant in the context of a Dow Jones Industrial Average of 10,000 or so. In other words, it's not the points that matter in the long run, it's the percentages. Even the biggest one-day numerical drop in the Dow's history -- 618 points on April 14, 2000 -- only amounted to a 5.7% decline of the total index.
You can't do anything to change these ever-present price swings -- but you can take steps to lessen their impact on your holdings. One of the best methods you can use to accomplish this is systematic investing, also known as dollar cost averaging.
When you dollar cost average, you invest the same amount of money, at regular intervals, in the same investments. For example, suppose you want to own stock in the Ever-Shut Box Co. If you were to dollar cost average, you would buy $100 worth of Ever-Shut every month. Let's say that your initial $100 bought you 10 shares of Ever-Shut, meaning its price was $10 per share. A month later, Ever-Shut's price falls to $5 per share, so now your $100 buys you 20 shares. The next month, a worldwide shortage of boxes drives the price of Ever-Shut up to $20 per share. Now, your $100 will only buy five shares. Over those three months, you have purchased a total of 35 shares at an average cost of $8.57 per share.
You can see what happened: When prices were low, your $100 bought more shares, but when they rose, that same $100 bought fewer shares. Dollar cost averaging won't guarantee you a profit, and it can't protect you from losses, but, over time, it can allow you to pay less per share than if you just invested lump sums at irregular intervals. Consequently, you could take a lot of the "sting" out of market volatility. However, since dollar cost averaging automatically invests your money on a continuous basis, regardless of fluctuating price levels, it is important to evaluate your risk tolerance and time horizon.
So the next time you see that the Dow has fallen a 100 points, don't panic. The situation is not as serious as it seems. If you dollar cost average, you'll find that lower prices on the market mean more shares in your pocket ... and that's not such a bad trade-off.
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com