It happens every time.
When stocks have been hammered down so much that the Dow Jones industrial average drops more than 20 percent from its previous peak -- as it did in October -- many investors rush to
redeem shares of equity mutual funds, regardless of how well they're managed, and seek refuge in money-market funds.
But let the stock market soar -- let the Dow be up over 25 percent from its previous cyclical low, as it was last week -- and the telephone lines to fund offices are jammed as investors want to switch from money-market to equity funds. Many who have not yet invested ask that purchase applications be rushed to them. Some people, anxious about missing one more day's market gains, even call for instructions on wiring money.
Is this any way to invest? Hardly.
Is it wrong to invest in equity funds when the stock market is at a cyclical -- or even historic -- peak? Not necessarily.
Since equity funds are best suited to building your capital over a period of years, it should not matter very much when you begin. If you assume that our economy will continue to grow over time, you have to believe that peaks in the stock market sooner or later will be succeeded by new peaks.
But because no one can possibly know what will happen to stock -- and equity fund -- prices in the short run, it's prudent not to invest too much at one time.
Anyone who was apprehensive about the market last autumn, has been watching the Dow regain 600 points, and concluded amid the recent euphoria that it was at last time to invest a large bundle risks being disappointed when a correction occurs.
While there are no sure ways to avoid stock market risk, there is a long-term strategy that takes the emotions out of investing and should provide satisfactory portfolio performance.
Commonly known as dollar cost averaging, it is simply investing on the installment plan. Easily applied to mutual funds, which permit small purchases, it involves investing a fixed amount at regular intervals, such as monthly or quarterly, through both up and down markets. You buy more shares when prices are low and fewer shares when prices are high.
The result should be higher long-term gains, since dollar cost averaging holds down your average cost.
To see how dollar cost averaging might have worked over a few years if you had begun when the market hit a peak, assume you've invested $100 at the end of every month from August 1987 through February 1991 -- a total of $4,500 -- and reinvested distributions.
If you could have invested all $4,300 at the start of the three-year period in the Standard & Poor's 500 Index -- the broad market gauge that many equity fund managers try to beat but only one in four excels -- the value of your holdings would have grown to $5,400, reflecting an annual total return of 6.75 percent.
If you used dollar cost averaging, your portfolio would have been worth $5,554.
How would you have fared if you had invested in a fund that has beaten the index over the long run?
If you had chosen a leading aggressive growth fund, such as Twentieth Century Ultra Investors, whose annual total return of 12.99 percent over this period was nearly double the S&P's, you would, of course, have done better.
By investing $4,500 in 327.494 shares at the end of August 1987, when a share cost $13.13, and reinvesting all the income and capital gains distributions since then, you would have acquired 568.259 shares by the end of last month, when the share price (not adjusted for distributions) was $11.60. They would have been worth $6,592.
But, as the table shows, if you had used dollar cost averaging, investing $100 monthly at prices across a wide range and reinvesting distributions, you would have accumulated 593.484 shares worth $6,684, or 4.4 percent more.
(Also to be taken into consideration: the use you would have had of your money, if you had not invested all $4,300 at the outset, and the higher income taxes that would have been due because of the greater distributions -- unless invested in an IRA.)
This illustration does not imply that Twentieth Century Ultra is a fund for everyone -- being highly volatile, as the table makes clear, it is not -- or that the advantage of dollar cost averaging over lump-sum investing is constant.
It does suggest that, if your investment horizon is long enough, dollar cost averaging can help you to overcome the risks of starting at a market high and of choosing a fund whose volatility is greater than that of the market, which, as you know, is volatile enough.
What's crucial, if you decide to adopt this approach, is that you identify a fund that's right for you -- one whose investment objectives match yours, whose volatility is not too great for you, and whose superior long-term performance record may be expected to continue.
Having made the choice, you only need the confidence to get started and the discipline to stay the course.