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You can't eliminate risk from your investment strategy, but you can help manage it and attempt to reduce it through several simple strategies.
Dollar Cost Averaging
Dollar cost averaging is a systematic approach to investing. It's a technique by which an investor allocates a specific amount of money for investment at specific intervals. Because the same amount of money is being invested at regular intervals, timing investments to coincide with market performance is not a consideration. The same amount of money is invested when the market is up as when the market is down. When the prices are low, the dollar cost averaging strategy simply buys more shares than when prices are high. Dollar cost averaging does not ensure profit or prevent loss. Since it does involve continuous investing regardless of market fluctuations, you should consider your financial ability to make purchases through periods of low and high price levels.
DOLLAR COST AVERAGING AT WORK
The following chart is a hypothetical illustration of a dollar cost averaging strategy that allocated $100 each month into the same investment over a period of six months in a fluctuating market. The chart is a hypothetical example and is for illustrative purposes only. This data is not intended to represent the performance of any particular mutual fund or investment. Please note that while the account in this illustration has gained value, a dollar cost averaging strategy does not guarantee a profit or protect you from a loss.
| Date |
Investment Amount |
Share Price |
Shares Purchased |
Total Shares Owned |
Month 1 |
$100 |
$10 |
10.00 |
10.00 |
Month 2 |
$100 |
$8 |
12.50 |
22.50 |
Month 3 |
$100 |
$5 |
20.00 |
42.50 |
Month 4 |
$100 |
$10 |
10.00 |
52.50 |
Month 5 |
$100 |
$16 |
6.25 |
58.75 |
Month 6 |
$100 |
$10 |
10.00 |
68.75 |
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| Total Amount Invested: $600 |
Average Price Per Share: $9.83 ($59/6 months) |
| Account Value on Month 6: $687.50 |
Average Cost Per Share: $8.73 ($600/68.75 shares) |
Diversification
Diversification means, simply, that you don't put all your eggs in one basket. To help reduce risk, you spread your investments in many different securities, across different industries and sectors and into several different asset classes. That way, if one portion of your portfolio performs poorly, it may be offset by another, which is doing well. Mutual funds generally provide some diversification, since they typically invest in a relatively large pool of stocks, bonds or other securities. However, to achieve the full benefits of diversification, you may need to consider several different funds that invest in different types of securities. Your financial professional can help you determine which strategies make sense for you.
Asset Allocation
Investing in mutual funds and spreading your portfolio among several types of investments can help reduce risk. Yet, once you have diversified, you can further fine-tune your portfolio's risk and return potential through disciplined asset allocation. Asset allocation is a strategy of spreading investment dollars among different classes of assets that matches your own personal time horizon, risk tolerance, and investment objectives. Investors often choose this strategy in an attempt to minimize the impact of any single investment class on the total performance of their investment portfolio. Some examples of asset classes are stocks, bonds, and cash equivalents.
In fact, one study has shown that your asset allocation strategy will have a greater impact on your investment portfolio's overall performance than security selection or market timing. The chart below illustrates this point:
WHAT INFLUENCES A PORTFOLIO'S RETURN?
Investing Internationally
Today, more than half the world's investment opportunities reside outside the United States, including many of the most dynamic companies and markets around the globe. The markets of foreign countries are affected by different economic and political factors than those that affect the U.S. market, and may perform dramatically differently. Foreign markets can and some historically have outperformed the U.S. market during specific periods; in fact, the U.S. has not been the top-performing market in any year during the last decade.1
Please note that international investing involves special risks, which include changes in currency rates, foreign taxation, and differences in auditing standards and securities regulation, political uncertainty and greater volatility. These risks are even greater when investing in emerging markets.
It's time, not timing, that makes a difference
Have you tried to buy at stock market lows and sell at stock market highs? If so, then more than likely you have learned a basic investment lesson - successful market timing is a very difficult endeavor. To be successful at market timing, you must be right twice - when to buy and when to sell. That is difficult for even the most seasoned investment professional.
The table below illustrates the potential penalty for trying to time the market. In fact, the performance return for an investor who missed out on the top 20 single-day market gains in the S&P 500 Index over the 10-year period ended December 31, 2003 would have been substantially less than that of an investor who was fully invested during that entire time period (0.24% versus 9.08%). Of course, this chart is for illustration only. There's no guarantee that remaining fully invested will ensure a gain. In addition, you can't invest directly in the S&P 500, an unmanaged index whose performance does not include the fees and expenses typically associated with mutual funds.
What's the penalty for missing the best market days over the 10-year period ended December 31, 2003?
| Investment period |
Average Annualized Return |
Growth of $10,000 |
| All days |
9.08% |
$23,838 |
| Miss the best 10 days |
4.06% |
$14,861 |
| Miss the best 20 days |
0.24% |
$10,239 |
| Miss the best 30 days |
-3.07% |
$7,348 |
| Miss the best 40 days |
-5.85% |
$5,528 |
| Miss the best 50 days |
-8.32% |
$4,269 |
| Miss the best 60 days |
-10.57% |
$3,359 |
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Based on performance of the S&P 500 Index January 1, 1993 through December 31, 2003. Please note the calculations do not include the reinvestment of dividends.
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