Mutual Fund Basics
Seeking a strategy for investing during a down market? A plan of systematic, or regular, investing can help you take advantage of changing market conditions — and avoid the futile approach of trying to time the market.
Regular investing can help you cope with the human tendency of hesitating to invest in a declining market, when stock prices may actually be more reasonable.
With an automatic investment plan, known as dollar cost averaging, an investor invests the same amount at regular intervals — for example, $500 each month — regardless of whether stock prices rise or fall. Using this strategy, investors can buy more shares at lower prices and fewer shares at higher prices.
A program of regular investing can help take the emotion out of investing when markets turn particularly volatile because your long-term strategy doesn’t change. There is no need to make a drastic adjustment. In fact, taking money out of the market or ceasing to invest during declines might result in selling low or missing the chance to add to a portfolio when prices are down.
“Automatic, regular investing also frees the individual investor from trying to forecast in the short term what the stock market will do,” says Gregg Ireland, a veteran portfolio manager for several American Funds. “Speculating what the stock market will do in the short term is like predicting the weather next week. It’s an unpredictable variable,” he says.
To illustrate the potential benefits of dollar cost averaging, take a look at the table below. In this example, an investor bought shares of a mutual fund at three regular intervals, paying $15, $10 and $20 per share. When the price fell to $10 per share, the investor bought more shares. When it rose to $20 per share, the investor bought fewer shares.
The key is that the average cost of the shares was $13.85 per share, whereas the average price on the market was $15 per share. This means that the investor was able to avoid paying an average of an additional $1.15 per share simply by investing regularly and using the power of dollar cost averaging.
Of course, to take advantage of a systematic plan, investors must be willing to stick to the strategy during bad markets. Regular investing does not ensure a profit or protect against loss, and investors should consider their willingness to keep investing when share prices are declining.
Now that we’ve discussed the potential benefits of dollar cost averaging, let’s look at how a systematic investment plan might have worked for an investor during the past two decades. For example, consider a hypothetical investment of $500 at the end of every month in Standard & Poor’s 500 Composite Index, with all dividends reinvested, over the 20 years ending on December 31, 2015.
During the 20 years of this hypothetical investment, there were periods of market declines with various highs and lows. But at the end of those 20 years, the investor would have built up an account balance of $260,572, which includes $35,694 in total dividend payments, on a total investment of $120,000. It’s interesting to note that the dividends ended up totaling 30% of what was invested.*
If you and your financial professional decide that an automatic investment plan makes sense, you can get one started online.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Standard & Poor's 500 Composite Index is a market capitalization-weighted index based on the average weighted results of 500 widely held common stocks.
Regular investing does not ensure a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.