Wealth Matters: Challenging Dollar-Cost Averaging and Other Bad Ideas

The sheer magnitude of the world’s problems — high unemployment and legislative gridlock in the United States, debt problems in Europe, signs of a slowdown in China — makes this a scary time for investors.

But what about the urge to take some sort of action? As I have written before, the better strategy is almost always to focus on a long-term plan and not abandon it the moment it gets tested. After the last three years, this is tougher to do than ever.

“It’s very hard to do nothing when everybody is trying to talk you into doing something, even when it’s wrong,” said Susan Fulton, founder and president of FBB Capital Partners.

Michael Martin, a trader and the author of the new book “The Inner Voice of Trading” (FT Press), put it a different way. The big risk for average investors now is confusing volatility with opportunity.

He said professional traders become more wary when prices are changing rapidly for no fundamental reason. And he equated the market, with its wild swings, to a drunken uncle at a holiday dinner. “When someone’s behavior becomes more volatile, you don’t want to warm up to that person,” he said. “You want to get away.”

But ignoring those swings can be difficult. Below are some bad ideas as well as some slightly contrarian thoughts that may offer comfort.

BAD IDEAS Fear causes investors to do all sorts of things that could hurt them in the long run.

The recent drop in gold prices to about $1,600 an ounce from just under $1,900 in August has damped down some of the enthusiasm for gold. But the gyrations in stocks have led some investors to think that they can find something there that will soar as gold did.

“People want to swing for the fences,” Ms. Fulton said. “We’re not going to have stocks that multiply by 10 in the near future.”

She said she advised clients to look instead at companies that had a lot of cash and were paying steady dividends. There is a predictability to those stocks that will help battered portfolios.

A variation on the stock-picking strategy involves using tax losses accumulated over the years to bet heavily on a risky company. The hope is that any gains will get an investor back to even and also be tax-free.

The problem is that unless the investor picks the next Google, his losses could be substantial. And even if he’s lucky enough to pick a stock that appreciates greatly, it could be years before he sells the stocks and is able to use the tax losses to offset the gains.

“You should use your tax losses on things that can benefit you today,” said Lewis Altfest, chief investment officer of Altfest Personal Wealth Management.

Mr. Altfest said a client recently wanted him to put money into some risky stocks because he was down so much. Instead of agreeing, Mr. Altfest suggested the client reallocate his portfolio back to 65 percent stocks and 35 percent bonds and then go back to that allocation whenever the stock position dropped below 63 percent.

“He’s got a human problem now — he’s behind,” Mr. Altfest said. “I could explain to him that this is the worst recession we’ve had in 80 years. It might help him intellectually, but he hurts, and he wants an answer.”

CONSOLING THOUGHTS One of the great comforts to average investors in a volatile market is dollar-cost averaging. This is a fancy way of saying you should invest your money over a period of time as opposed to investing it all at once, which is known as lump-sum investing.

Proponents of dollar-cost averaging offer two arguments. By putting money into, say, a stock over time, you will be buying shares at varying prices, which will benefit you in the end. This seems particularly appealing when stock prices are rising and falling so much.

The second advantage is psychological: If you put all your money into an investment and it is worth 10 percent less the next day, you’re going to feel horrible about it. Worse, you may also be less inclined to make further investments or pull your money out.

But new research from Gerstein Fisher, a money manager in New York, raises questions about that investing philosophy. It found that from January 1926 to December 2010, investing your money on one day yielded better results over a 20-year period than investing the same amount of money in equal chunks over 12 months.

Article source: http://feeds.nytimes.com/click.phdo?i=90a4d733ac782efae338a23b99bea603