Originally created 08/30/98

Risk can be reduced



Three years ago, Debi Flippo started socking away money in mutual funds.

Ms. Flippo, an office manager at the Edward Jones branch in North Augusta, had seen wise investments make people rich. She didn't have a lot of money, but with a little faith and about $100 a month, she got into the game too. The money came directly out of her paycheck.

Now, Ms. Flippo says, she has investments worth about $9,000.

It's not a fortune. But it's not bad for little more than $100 a month.

What Ms. Flippo is doing, investment experts say, is dollar-cost-averaging.

She's buying stock on a schedule, a little bit at a time every month. When stock prices are high, her $100 buys fewer shares. When stock prices are low, the same amount buys more.

Investment experts say, the strategy almost always pays off.

The perfect investment scenario is buy low, sell high. But in a volatile market, such as this one, it's difficult to tell when stock prices will be up or down. Dollar cost averaging takes some of the risk out of investing.

On Thursday, for example, the Dow dropped more than 350 points, then fell another 114 points on Friday.

If this is as low as the market is going to get, now could be a good time to buy. If, however, it drops further, it could be a bad investment.

Dollar cost averaging says buy some shares now, buy some later. So on average, the risk is minimized.

It takes the emotion out of investing and works on the law of averages. This way investors don't have to sweat it out if the market falls or wonder if they should sell when it's high.

Smoothing bumps

Many investment plans work on the principle of dollar cost averaging.

Retirement accounts such as 401(k)s and dividend reinvestment programs, are examples. These plans invest money in stocks on a systematic basis.

"The thing is, over a long period of time, by dollar cost averaging -- investing a fixed amount over a period of time -- you may have an opportunity to accumulate shares," said Wes Martinez, a broker at Charles Schwab's Augusta branch.

If an investor buys a good, solid company, dollar cost averaging probably will not make more money than buying all the shares at once. But if the company has some bad years, then over the long term it could pay off.

Dollar cost averaging works well for investors who don't have a lot of money to invest at one time.

And while the technique takes some of the risk out of investing, it won't make an investment bullet proof.

Investors who buy stock in risky or failing companies, shouldn't expect to make money, investment experts say.

How it works

Chuck Smith, a broker for Edward Jones, calls dollar cost averaging "The Eighth Wonder of the World." It tends to smooth out bumps.

Here's a hypothetical example of how the strategy works:

Investor A buys 872.18 shares of Home Depot for $14,200 in January 1993.

He reinvests his dividends and does not sell any of his shares for about 5 1/2 years. At the end of that time, the value of his shares has gone from $16.28 a share to about $41.87 a share.

His 890.24 shares are now worth $37,278.95 -- a good investment.

But, what happened in those 5 1/2 years? For three years, Investor A had his $14,200 tied up in stock that did not rise in price. So if he were to sell during that time, he would have lost money.

He also could not touch that $14,200 investment.

Investor B, on the other hand, dollar cost averages.

He buys 61.42 shares of Home Depot for $1,000 at the same time as Investor A plunks down his $14,200. But he buys $200-worth of Home Deport stock every month for the next 66 months at prevailing market prices and also reinvests dividends.

At the end of about 5 1/2 years, Investor B has also invested $14,200.

He has 853.67 shares of stock worth $35,747.41 -- not quite as much as investor A. But he has assumed less risk.

While the first investor would have lost money if he had pulled out of Home Depot before 1996, Investor B could have liquidated his assets with little or no loss. And had Home Depot started to flop, Investor B would not have had to take as much a loss.

Investment costs

There are some investment costs that the above example does not take into account. If an investor uses a broker, he or she may have to pay some management fees and commissions.

The fees vary, depending on the broker, type of investment and amount.

Generally, Interstate/Johnson Lane broker Scott Benjamin said, investors who plan to buy small amounts of stock through a broker are better off investing in mutual funds until they can save up enough capital to make a larger investment in individual stocks.

Interstate/Johnson Lane, for example, generally has a minimum fee of $50 every time an investor buys stock. If an investor is investing only a few hundred dollars a month, the fees can add up. In the above example, Investor A would have paid less than $500 in fees while Investor B would have paid $3,350.

With small amounts of money, mutual funds are less expensive.

But there also are ways to invest without a broker and reduce fees.

Mutual funds sold directly through the fund company, also known as no-load funds, have an annual management fee that is about a half percent less than a load fund, Mr. Benjamin said.

And stocks sold through a company's dividend reinvestment plans, may also have no minimum fees to purchase.