Invest a Fixed Amount Regularly and for the Long Term
When markets plunge, it's tempting to protect your savings by cashing out of stock mutual funds and staying on the sidelines until the market turns around. The problem with this strategy is that no one can predict when the market will hit bottom and begin to rise again.
With defined contribution plans such as 401(k) and 403(b) plans forming the bulk of most individuals' retirement plans, how you invest for the long term determines how you'll live after you retire. Keeping your money in cash that earns 2 or 3 percent a year won't fund your retirement. Neither will bond funds, which have historical returns significantly below those of stocks and stock funds.
As for stocks and stock mutual funds, the past couple of years have taught us that buying on market dips doesn't provide an immediate reward. Buying through bear and bull markets, however, will typically reward investors in the long term. Mutual funds are uniquely suited for investing a fixed amount regularly and for the long term. Many of them have free dividend reinvestment plans and low minimum investment requirements. Many employers also provide matching funds for their retirement plans.
To fund a child's college education, start when the child is a baby by investing $100 a month or more in a stock mutual fund within a Section 529 college savings account. You'll likely be in a position to pay for a large portion of those expenses when the time comes. Section 529 plans are state sponsored college savings plans (see "Mutual Fund Matters," October 2002).
When you invest in a fund month after month, in good times and bad, you're dollar-cost averaging. Your money buys fewer shares when fund share prices are higher and more shares when fund share prices are lower. This lowers your cost basis, the average price you paid to purchase fund shares.
Continuing to buy fund shares when your fund is down by 10, 20 or even 30 percent means that you're buying more lower priced shares and will gain more when the market turns around, which it inevitably will. I don't know when the market will turn around, and neither do commentators on financial news channels. But history shows that bear markets are inevitably followed by bull markets and that the stock market's general bias in the past 100 years is upward.
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