By Ben Baden
Despite plenty of forecasts, no one really knows where the stock market is headed. But many investing experts agree that average investors with a long-term mindset should consider dollar-cost averaging--investing a set amount of money on a regular basis over an extended period of time--instead of trying to time the market and investing a lump sum.
One of the most common mistakes investors make is letting their emotions take charge in times of stock market turbulence. It can be difficult to sit still when stocks are in freefall, and it's tempting to buy when stocks are on a tear. With dollar-cost averaging, investors can make a plan to invest on a consistent basis, which can keep them from making decisions based on the latest twists and turns of the market.
"There's an inclination when stock markets are down for people to stop [using dollar-cost averaging], but that's really the best time," says Adam Bold, founder of the Mutual Fund Store.
"The best part about dollar-cost averaging is that sometimes you're getting more shares at lower prices." Investors will also inevitably end up buying some shares at higher prices.
The market meltdown in 2008 scared many investors away from stocks and they poured into safer investments like bonds. Subsequently, many of those investors missed the incredible rally in 2009. Investors who were dollar-cost averaging were able to buy some securities at rock-bottom prices. Says Bold: "Even if you go back to the last really terrible market between the fourth quarter of '08 and the first quarter of '09--people who were dollar-cost averaging--how lucky were they to have been able to buy shares during that time?"
Critics of dollar-cost averaging say that by only investing small amounts over time, you could miss out on great opportunities, such as strong market pullbacks, to invest a lump sum of money. "Let's say we expect an upward-trending market," says Christian Hviid, director of market strategy at Genworth Financial Asset Management. "Dollar-cost averaging is going to hurt you on a relative basis versus putting all your money at work right away." But Bold points out that it's extremely difficult to time market accurately.
Bold says now is as good a time as any to start investing. He suggests investing half of your money to start, then investing 20 percent of your remaining funds on the same day of each month over the next five months. After implementing this strategy, Bold says the only thing you need to do is occasionally check up on your investments.
If you're going to invest a set amount on a regular basis, it's important to know how much you're paying in transaction costs. If you're purchasing individual stocks, mutual funds, or exchange-traded funds, fees associated with buying or selling can eat into your initial investment. Brokerages charge investors for buying individual stocks and shares of ETFs.
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