Averaging methods could be a way back into the market

By Nancy Schultz | Apr 30, 2009

Investors have every reason to be skittish about the current, uncertain markets. Some merely sit on the sidelines and wait for a definitive turn to the upside.

However, active but wary investors sometimes choose to slowly get back into the market through dollar-cost or value averaging. Either method has a potential advantage compared to doing nothing, simply because it allows an investor to participate in any market upside if and when it emerges from the slump. That could be of value because as markets rise from their lows, the first months and years are typically much more profitable than later on, when most investors have decided it’s safe once again. Of course, neither method guarantees a profit or protects against a loss in a declining market.

Value or dollar?

Dollar-cost averaging gets you into the market gradually. You establish a timetable and invest the same amount regularly, knowing that when the market is down you’ll be buying more shares of stock or a mutual fund than when share prices are higher.

Say your $1,000 investment one month buys 100 shares at $10; the next month, shares are worth just $9.25, so your $1,000 buys 108-plus shares. Over time, as the price per share seesaws a bit, you may find you have paid less per share than you would if you had bought a fixed number at any one point.

A slightly more complex variant of this is value averaging. To do this, you set a goal – say $12,000 by the end of the year. Your $1,000 the first month buys 100 shares of a $10 stock. The following month, with the share price at $9.25, you’ll put in $1,075 to bring the total value of your portfolio to $2,000.

Neither method is magic, but each requires some investing discipline and either may prevent your making a huge purchase at just the wrong time.
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