Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.
Times are tough. The stock market is up and down, not like a roller coaster, more like a ride that takes you straight up, then drops. It's exhilarating for some, frightening for most. When stocks move this fast, they present opportunities. One way to take advantage is to use an old investment idea called Constant Dollar Investing. Here's how it works.
You make a commitment to invest the same number of dollars each month. You buy one stock, or a different one, every month. Usually investors buy a fixed number of stocks, adding to each position one at a time. What this does is give an investor an overall lower cost of buying a full position in a stock. Here are the numbers.
If an investor puts $100 a month into the market, and starts buying a stock at $5 a share, the first month, he/she will buy 20 shares (excluding commissions). If the stock moves to $10 the next month, the investor will buy 10 shares. If the next month, the stock goes to $2, the investor picks up 50 shares. In three months, there are 80 shares in the portfolio at an average cost of $3.75.
What happens is very simple: the constant dollar commitment buys more shares when the stock is low in price, fewer shares when it's higher. Therefore, investors come out with an overall lower price when the position is filled. Of course, if an investor were really lucky, he/she could buy all the stock at the low point and have 150 shares. How many of us get that lucky?
On the other hand, if an investor got too excited, was afraid the stock would run away, and bought a full position when the stock was trading at $20, he/she would have only 15 shares. In my experience, this scenario is more likely than an investor picking up 150 at the low.
The important part of this program is stay emotionally uninvolved, to let the market go through its gyrations while you systematically buy stock. You don't have to buy stock on the same day every month but it's important to allow time between purchases and to only use the same dollar amount each time. Don't get too excited when the stock is down and double up your commitment. The same is true when the stock is finally moving ahead. Excitement is your enemy. With this program, you take emotion out of the picture.
Try this program on a stock you want to add to your portfolio, or for all the ones you want to buy. You'll find that some of the stocks will move ahead, and you only buy a few shares each month. More likely, however, you'll find yourself amazed at how this volatility gives you great opportunities to pick up stock at great prices. But you have to have discipline to take advantage of these gyrations. Get too excited and you'll buy all your stock when you think the market is finally going to take off. Then next month, you may be wrong and out of money.
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