investing

Dollar Cost Averaging

By in Finance and Accounting, Living Well, Uncategorized Tags: , ,

StockMarket

It sounds almost too obvious. Investment advisers tell you to buy low and sell high. So what’s the trick? The principle is that you should buy investments at a low price. When those investments rise in price, you should sell them. Most professionals save for their retirements, and they buy mutual funds rather than individual stocks.

The problem is that people often do exactly the opposite of what this conventional wisdom tells them. They listen to people talk about a “hot” investment. The buzz causes prices to rise. People enthusiastically rush in to buy the mutual fund. By that time, conditions have changed. The price falls. Disillusioned, the once enthusiastic investor takes the loss and dumps the investment. In other words, people buy high and sell low.

So what’s the solution?

The solution is actually rather boring, and it doesn’t make for good cocktail party conversation. Ordinary mortals should give up on the idea that they can “beat the market.” Investments are best made slowly and steadily over a long period. For people saving for retirement, a steady and substantial contribution to a retirement fund is a good idea. When the price rises, the same investment amount buys fewer shares. When the price dips, the funds are “on sale,” and you wind up with more shares. Over the long haul, markets tend to rise anyway.

When equity markets dip over 10%, experts call it a correction — and this has happened recently. Professionals looking at their hard-earned portfolios easily become discouraged. Some people decide to take refuge in the safety of money market funds and they sell their mutual funds.

That is exactly the wrong approach. The right approach is to hang in there and comfort yourself that you are buying more shares for your money as you continue to invest. The price averages out over time — and that is what advisers mean when they talk about dollar cost averaging.

This requires patience and discipline rather than a sharp eye for a hot investment.

 

What Is an ETF?

By in Living Well Tags: , , , ,

ETF

In a previous post, I discussed what a mutual fund is.

Today’s post describes another financial instrument, the ETF. ETF stands for Exchange Traded Fund. An ETF is very much like an index mutual fund, the kind of fund that buys into a market index rather than actively trying to outperform the market.

There is one very important difference, however. A mutual fund cannot be bought and sold on the fly in the way a stock can. With a mutual fund, you put in your order, and the trade is executed at the end of the next trading day. Many mutual funds have other ways of discouraging investors from behaving like traders.

With an ETF, you can behave like a trader. You buy and sell your ETFs just like stocks. For example, in the middle of the day, you hear some bad news and you learn that financial markets have dipped because of the news. You believe that the dip is only very temporary, and you speculate that the markets will return to normal after the dust has settled. You can buy in the morning and sell in the afternoon. Commissions tend to be low, and the internal costs of running an ETF tend to be low as well.

Some people avoid ETFs because they prefer the restricted world of the more boring mutual funds. Perhaps the biggest mistake investors make is to begin to speculate rather than invest. The flexibility of an ETF encourages people to speculate, and some think that’s a flaw.