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BY ABRAHAM HOROWITZ
With all due apologies to Noah Webster, recent financial market developments have shown that you can't spell investment without "R-I-S-K." But experience suggests that simply by concentrating on two A's Allocation and Averaging personal investors can continue to write success stories.
Time has shown that Asset Allocation and Dollar Cost Averaging can be integral elements in a long-term investment strategy. Those who stick with a well-designed plan, with clear financial objectives, that fits both their financial situation and tolerance for risk are generally rewarded for their discipline. Their overall track record is normally superior to those who try to time their investments by flipping in and out of the market or by concentrating their investments in "hot" markets.
MONITORING THE MIX - Both allocation and averaging are somewhat rigorous approaches that at times require a strong stomach. For example, once you've decided on a suitable asset allocation, you and your financial planner will need to watch your portfolio results closely in order to keep the right mix. You're likely to face some pretty tough decisions. Say you've decided on the following allocation for your portfolio: 60 percent stocks/30 percent bonds/10 percent money market instruments. But the stock portion's growth quickly outpaces the increase in value of your bonds. Now you've got a dilemma if you stick to the plan should you sell off a portion of the successful stock segment in order to buy more of the bonds and money markets, which aren't doing as well?
That kind of question can give even disciplined and experienced investors a quick dose of indigestion. Complicating matters, you also have to evaluate the tax and transaction costs of buying and selling, and you need to consider allocation changes whenever your personal circumstances change.
You might be able to make your life somewhat simpler and still benefit from the time-tested advantages of asset allocation by buying mutual funds that practice allocation strategies similar to yours. Even so, that still won't excuse you (and/or your financial advisor) from regularly monitoring your portfolio if you intend to maintain a truly diversified and appropriately balanced portfolio.
"TIME IN THE MARKET IS MORE IMPORTANT THAN TIMING THE MARKET" - This old maxim states a basic truth for those looking to set up a portfolio for the long-term: the sooner you can begin an investment program, the better. And many professional financial investment advisors favor dollar cost averaging - the disciplined practice of making regular, periodic fund purchases by investing the same dollar amount each time you buy. In that way, you'll be buying more shares when the price is low, and fewer when it's high.
Dollar cost averaging can make market fluctuations work for, rather than against you. The inherent discipline of such an approach is generally regarded as far sounder than trying to time your purchases to market developments. Not only is that difficult to do, the hesitancy that may result could cost you some excellent opportunities as you sit on the sidelines.
Dollar cost averaging is extremely effective if the share price declines and then recovers, as illustrated by the accompanying chart, but the strategy demands that you have the fortitude to stick with it, even when the market sags.
THE ADVANTAGE OF DOLLAR COST AVERAGING
(based on a hypothetical investment of $100 per month)
| Month | Share Price | Shares Bought | Portfolio Worth | Total Investment | Net Gain/Loss |
| 1 | $20 | 5.00 | $100 | $100 | 0.00% |
| 2 | $18 | 5.56 | $190 | $200 | -5.00% |
| 3 | $16 | 6.25 | $269 | $300 | -10.37% |
| 4 | $14 | 7.14 | $335 | $400 | -16.18% |
| 5 | $12 | 8.33 | $387 | $500 | -22.52% |
| 6 | $10 | 10.00 | $423 | $600 | -29.53% |
| 7 | $13 | 7.69 | $650 | $700 | -7.19% |
| 8 | $15 | 6.67 | $850 | $800 | 6.20% |
| 9 | $14 | 7.14 | $893 | $900 | -0.78% |
| 10 | $17 | 5.88 | $1,184 | $1,000 | 18.43% |
| 11 | $19 | 5.26 | $1,424 | $1,100 | 29.42% |
| 12 | $20 | 5.00 | $1,599 | $1,200 | 33.22% |
This dollar cost averaging approach can be applied effectively to a host of investment programs, including annuities, mutual funds and IRAs.
LUMP SUM CAVEAT - Averaging is a great way to invest in increments, but its effectiveness can wane over a period of years as the impact of early returns tends to be diminished by the growing portion of your account that was purchased at later dates. If you come across a large lump sum or inheritance, you might want to think about investing it more quickly, especially if you have confidence in the stock market's demonstrated ability to rise consistently over time.
CONCLUSION - Investing is serious business that requires discipline to be successful. Implementing an asset allocation model which takes into account your time horizon and risk tolerance is one way to increase your chances of long term success. Additionally, dollar cost averaging can be the best way to gradually build your portfolio; buying more shares when the price is low, and fewer when the price is high. These two methods can be used together in a long term strategy to meet your financial goals.
Abraham Horowitz is a Financial Planner specializing in investment management, tax planning, and estate planning. He holds a bachelor's degree in Finance from the University of Miami and a JD from the Ohio State University School of Law. He works with Prudential Financial Planning Services, at 2 Alhambra Plaza, suite 100 Coral Gables, FL 33134. For more information or to contact Mr. Horowitz, please call (305) 443-0600 ext. 7039.
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