Section I - Lesson 4E
Financial Plan - An Ideal Timing Strategy
Step five of your financial plan is to employ an ideal timing strategy for purchases of your ideal investment vehicle, the S&P 500 Index fund. Fortunately, there's a very easy solution to this problem. You won’t have to worry about it! In no way, shape, or form will you ever need to try to pick the perfect time to buy or sell your mutual fund shares. It’s not necessary.
This is because you will use the investment approach called “dollar cost averaging” which means you will regularly and automatically buy a fixed dollar amount of your fund every month or every pay period without regard to whether the price of these shares is up or down at the time you invest.
The “magic” of this approach is that your fixed dollar amount buys more shares when prices are lower and fewer shares when prices are higher, and you end up investing quite efficiently. The average cost of your shares is favorably influenced by the fact that you automatically get more shares for your money when the market is down, and fewer shares for the same amount of money when the market is higher.
Your procedure for investing in this manner will again differ between your 401k plan and your regular money account. With your company 401k plan, at the same time you tell your benefits people how much to deduct from your paycheck, you’ll also tell them how to invest the money. As we’ll discuss later, you’ll tell them to invest 100% of your contribution into the fund that most resembles an S&P 500 Index.
With your regular money account you have one extra step to take. You’ll have to choose the mutual fund company that you want to use, contact them through an 800 number or website, and arrange to open an investment account. They’ll usually require you to meet a certain minimum dollar amount on your opening transaction, as we’ll discuss in Section IV, after which you can invest as little as $50 every month.
You’ll tell them you want to automatically invest a regular dollar amount (such as $180, for example) every month into their S&P 500 Index fund, and that they should debit your bank account for this amount monthly on whatever date you select. The mutual fund company will have you complete some paperwork, forward your opening deposit, and will set you up for regular, automatic investment.
Dollar cost averaging eliminates the problem of trying to outsmart the market and decide whether it’s getting ready to go up or down. Even the greatest minds on Wall Street don’t succeed at this with any degree of regularity, and neither will we. The good news is, we don’t even need to try to do this. We just buy a fixed dollar amount regularly and automatically over the long term and we can expect to do extremely well.
We will speak a great deal more about this technique in Section II regarding Basic Principles, and we will utilize the technique with both your 401k (or IRA) and your regular money investments when we cover these in Sections III and IV respectively.
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