Volatility in financial markets is a fact of life that can play on the psyche of investors.
Periods of volatility like we've experienced can either keep investors out of the markets altogether or cause them to act on emotion and sell when they go down and buy when they go up, which is just the opposite of what they should do.
Investing regularly through a continuous savings plan is one of the best ways investors can take advantage of an investing technique known as dollar cost averaging (DCA) and generate wealth during periods of market volatility and fluctuations.
DCA is intended to reduce exposure to risk associated with making a single large purchase. The idea is simple: spend a fixed dollar amount at regular intervals on a particular investment, portfolio or part of a portfolio, regardless of the share price or market value. By doing this, more shares are purchased when prices are low and fewer shares are bought when prices are high.
DCA is a good strategy for all types of markets.
In a falling market, it can let you purchase more securities; in a rising market it protects you from paying too much; and in a flat market it ensures that you stay invested.
Since the market has a positive mean rate of return, dollar cost averaging usually requires the investor to give up some returns for the benefit of reduced risk.
Basically it saves you from yourself since you are not the one trying to decide where the market is going and can save you from making many of these common mistakes.
DCA has an added advantage of letting the value of your investment compound over time and taking away the negative turns in the market.
Regular investing over a long period during good markets and bad has some other benefits.
It creates a savings first approach to your finances. Most people find it a lot easier to set aside small amounts of money over a period of time than coming up with a large lump sum at one time.
Some financial products available to investors let them automatically save and invest.
Dividend Reinvestment Programs (DRIPs), for instance, allow investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the date the dividend is paid.
A DRIP is an excellent way to increase the value of your investment. Most DRIPs allow you to buy shares commission free and at a discount to the current share price. Dividend paying stocks generally provide less volatility and excellent returns.
Life cycle mutual funds are another financial product that is suited for people who are averse to volatility.
Unlike traditional mutual funds, life cycle funds mature or end on a specific date in the future, typically five, 10, 15 years or even longer. The end date usually coincides with an important event in the investor's life, such as retirement or a child's graduation.
As the target end date approaches, the overall asset allocation of the fund will adjust to become more conservative. This helps investors take advantage of market growth opportunities at the beginning while protecting the value of the fund as it gets closer to maturity.
Investors should set their own financial targets and first save in their RRSPs to take advantage of compounding and the immediate tax benefits.
And one of the best ways to do that is to use dollar cost averaging. Over time, it can be a great creator of wealth.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.
Copyright 2012 Talbot Boggs
