Stock investing without an investment strategy doesn’t work. The question is: how to invest in stocks with less risk while earning good returns. Here’s a proven investment strategy, a tool that works but only if used properly.
You can use a tool called DOLLAR COST AVERAGING to lower your risk and improve overall performance if you invest in stocks periodically over time (like in a 401k plan). You can also use this investment strategy when you have a lump sum of money you want to invest in stocks.
Here’s an example of how to invest in stocks using this tool with a general diversified stock fund as the stock investment. Why we use this as our stock investing vehicle will be explained later.
Picture that you have $50,000 you want to invest in stocks, perhaps sitting in your 401k plan. The stock market is getting volatile and you want to decrease the risk of investing at the wrong time.
Solution: Use dollar cost averaging by investing the same amount of money systematically at predetermined intervals. In this case our investment strategy will be to invest the $50,000 by investing $10,000 every three months, for 5 quarters, into a diversified stock fund. Watch what happens as we invest the same amount of money each time period as the fund price fluctuates over time.
1st stock investment: $10,000 at $20 buys 500 shares.
2nd investment: $10,000 at $15 buys 667 shares.
3rd investment: $10,000 at $10 buys 1000 shares.
4th investment: $10,000 at $15 buys 667 shares.
5th investment: $10,000 at $20 buys 500 shares.
Totals: $50,000 invested … 3334 shares purchased and owned.
Total value of stock fund investment: 3334 shares x $20 = $66,680.
The share price fell and then recovered to end at the same price it started at. The same amount of money was invested each time, with purchases ranging in price from $20 to $10. Had you invested $50,000 upfront in a lump sum at $20, you’d have had a rough ride and been happy to just break even a year later. Instead you made a profit of $16,680!
When you invest in stocks by dollar cost averaging be careful. Do not use this investment tool with an individual stock, especially with a speculative one. This is poor money management. Why?
When you continue to invest in stocks and buy more shares in a declining stock market you are making an assumption: that stock prices (in general) will eventually recover in the not too distant future. This is a reasonable assumption, since it has always happened throughout the history of the U.S. stock market.
On the other hand, every year a number of individual stocks decline and never recover. Even major stocks can go bust … for example, General Motors.
Make dollar cost averaging a part of your overall investment plan. It forces you to buy more and more shares as stock prices get cheaper and cheaper. This results in a lower average cost per share.
Make sure that your stock investment is a bet on the U.S. stock market in general vs. an individual stock that could drop off the face of the earth leaving you broke.
Learning how to invest in stocks with an investment strategy that smoothes out the level of risk is key to being comfortable with your stock investing.