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Money Talks: Reduce the Effect of Volatile Markets

Reprinted from PN July 2001
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People often delay investing because they fear acting at just the wrong moment—e.g., when the markets are spiking and prices are high or the market is down and prices are dropping. Investing gradually can be an effective way to overcome the uncertainty about whether or when to invest.

Many people reduce the effects of market volatility by investing at regular intervals using a technique called dollar cost-averaging. This is a time-tested strategy with the potential to help you earn attractive risk-adjusted rates of return.

Dollar cost-averaging involves putting a fixed dollar amount into the same investment at regular intervals, rather than in one lump sum. For example, you might invest $100 a month into a mutual fund—a total of $1,200 a year—rather than all at one time.

By investing the same dollar amount on a periodic basis in the same security, you may pay a lower cost per share, which increases your potential to earn a profit. You automatically buy more shares when prices are down and fewer shares when prices are high. Over time, your average cost per share may be lower than the average share price of your investment.

For dollar cost-averaging to be effective, you must invest over a period of time, even during flat or declining markets. This discipline works against many people?s natural inclination to buy in rising markets and sell or defer purchases in times of decline. Before you embark on this strategy, consider carefully whether you would continue to invest during unfavorable markets.

Reinvesting dividends from your investments is another way of dollar cost-averaging. By reinvesting your dividends into additional shares of your investment, you?re investing a fluctuating but fairly fixed amount (the dividend) at regular intervals. Again, you are buying more shares when prices are low and fewer shares when they are high. Most financial institutions offer low or no-cost automatic dividend-reinvestment programs.

Investing regularly lessens the chance you'll make decisions at just the wrong time. Dollar cost-averaging can enable you to stick with a program over the long term that will help you achieve your financial goals.



Rosemary Berkery is senior vice president and director of the Merrill Lynch Private Client Marketing Group. Visit the company's Families of Children With Disabilities Program Web site, www.plan.ml.com/specialneeds. Contact: David Cleary, financial consultant, Merrill Lynch Private Client Group, (800) 937-0405 / (949) 859-2932 / DCleary@pclient.ml.com.

 

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Money Talks: Reduce the Effect of Volatile Markets

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