Buying mutual funds on the 'installment plan' for long-range gains
If you're still looking for a way to climb on this bull market, mutual funds may be a comfortable saddle. Even though it may seem hard to find losers in a market like this, people often like the assurance of professional full-time management and a diversified portfolio to cushion a sudden decline in any one stock or industry.Skip to next paragraph
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Many who invest in mutual funds usually do so when they have some spare cash. At irregular intervals they put in a few hundred dollars here, a few thousand there, whatever they can afford.
But a more effective way is with a system known as ''dollar-cost averaging.'' It's sort of like investing on the installment plan, and as with any installment purchase, you make the same size payment every month, every quarter, or whatever period of time you choose. This way, an investment program takes on the characteristics of a savings program, and while the results may not be as spectacular as picking a ''hot'' stock, the prospects for success by the average investor are greater. The alternative, timing investments to take advantage of market upturns, is extremely difficult to achieve. In recent years there were many false starts before the genuine stock market boom started last August.
The scary part may come when you make a commitment to yourself to put in the same amount every period, no matter how low the market gets.
''Do not consider this method unless you're willing to put on blinders to what the market is doing,'' comments Paul Reed, editor of United Mutual Fund Selector, a Boston newsletter.
The idea behind dollar-cost averaging is that when the market is down and the value of mutual fund shares is also low, you are buying more of these cheap shares. Conversely, when the market is up, you are buying fewer of those more expensive shares. Meanwhile, the value of the cheap shares purchased earlier continues to grow.
Because more shares are purchased in down markets, money invested through dollar-cost averaging starting 10 years ago would be worth more now than if the same amount had been deposited as a lump sum then left to grow over those years.
Dollar-cost averaging is also used by people investing directly in the stock market; they invest the same amount of money at predetermined intervals, purchasing as many shares in a stock as that amount of money will buy. But the system works even better with mutual funds, where fractions of shares can be purchased and, in some funds, where small minimum investments - sometimes as low as $25 - can be made.
The size of a minimum investment should not be the main criterion in selecting a mutual fund for dollar-cost averaging, however. The fund should have a fairly long record of good performance and should probably be a no-load (without a sales charge) fund.
Mr. Reed says one reason dollar-cost averaging works better than lump-sum investing is that ''it has the virtue of taking judgment out of the equation.'' Judgment is used to select the mutual fund group, and a specific fund in the group, but that's about as far as it goes.
Last year Mr. Reed examined how dollar-cost averaging might work in five types of markets: a steadily rising market; an inverted-bowl market, where prices go up, then head back down; a steadily declining market; a saucer-shaped market, where prices dip then go back up; and a seesaw market.
In his study, Mr. Reed compared the effects of investing $2,000 as a lump sum or making 10 payments of $200 in each of these periods. Interestingly, the least effective period for dollar-cost averaging turned out to be the kind of situation we seem to be in now - a steadily rising market.
The most effective market for dollar-cost averaging turned out to be the saucer-shaped variety. When the market is declining, the investor is buying an increasingly large number of shares with the same amount of money. As the market turns up again, previously-purchased shares are growing in value.
This does not mean investors should not embark on a dollar-cost averaging program in this bull market. For one thing, it's a good habit to get into. And in a long-term investing system, it really doesn't matter when the habit begins.
For another, should the market continue to rise, current share prices of mutual funds will be cheap in a few months, giving you more shares now than you could get later.
Finally, you won't be trying to invest all your money in the market now, when prices are high, then have to worry about a big drop later.
But if you are convinced the market is going to keep rising and are willing to take the risk of an unexpected drop, you may find this is a good time to make a lump-sum investment - assuming you have such a lump to invest.
Dollar-cost averaging is not a get-rich-quick idea. But then, responsible mutual fund executives never said they could make people rich. What the system will do - or at least has done in the last decade - is provide a way to do better than the often-quoted stock market averages without taking on excess risks.
If you would like a question considered for publication in this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.m