Information about...

1. Commercial Agriculture
2. Environment & Natural Resources
3. Fisheries & Aquaculture
4. Food, Nutrition & Health
5. Home, Lawn & Garden
6. Youth, Community & Economic Development

Diversify and Dollar-Cost Average To Reduce Investment Risk

Late savers and older investors who have had big losses in the stock market may be tempted to invest in a few "hot" stocks or mutual funds in an attempt to make up for lost time. This is rarely a good idea, however. People in their late forties through sixties simply don't have much time to recoup their losses when they are so close to retirement. The trade-off for limiting investments to just a handful of companies or market sectors (e.g., technology) is reduced diversification and a greater potential for loss.

A much safer investment strategy is to diversify and dollar-cost average. Diversification means spreading your money among different investments to reduce the risk of loss from a decline in any one investment. There are several easy ways to diversify investments:

• Place money in several asset classes (e.g., stocks, bonds, cash, and real estate), a strategy known as asset allocation.
• Choose different investments within each asset class (e.g., stock from different industries).
• Purchase investments, such as mutual funds and exchange-traded funds that contain diversified portfolios of stocks or bonds.
• Purchase stock and bond index funds that track broad market indices.
• Purchase an asset allocation fund that includes three asset classes--stock, bonds, and cash.

Dollar-cost averaging is the practice of investing equal amounts of money (e.g., $50) at a regular time interval (e.g., monthly), regardless of whether the value of investments is moving up or down. A common example is the amount that workers contribute to a tax-deferred retirement plan each pay period. Another is monthly deposits that are automatically debited from a bank account and transferred into a mutual fund investment plan.

Dollar-cost averaging reduces average share costs over time. Investors acquire more shares in periods of declining share prices and fewer shares in periods of higher prices. When dollar-cost averaging is practiced over long time periods, time diversification reduces investment risk. A simple illustration of dollar-cost averaging can be found in the table below. The average cost per share is $7.06 ($300 divided by 42.50 shares).















 

Illustration of Dollar Cost Averaging

Time Period	Regular Investment	Share Price	Shares Acquired
Month 1	$ 50.00	$10.00	5.00
Month 2	$ 50.00	$ 8.00	6.25
Month 3	$ 50.00	$ 5.00	10.00
Month 4	$ 50.00	$ 5.00	10.00
Month 5	$ 50.00	$ 8.00	6.25
Month 6	$ 50.00	$10.00	5.00
Total	$300.00		42.50