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Strategy to buy mutual funds

ITIPress.org - Marlon Jerez/ Consulting in Economics and Finance

The best strategy to invest in mutual funds or any other investment is “buy cheap and sell expensive”. This is the way to make a lot of money buying shares when they are close to their lows and sell them when they are at their highs.

This looks simple, but to implement this strategy is not easy; it requires a continuous follow-up on market prices to know the moment when shares are near to their lows or highs. Not always will you be able to buy all your shares at the lowest possible price, but there is a simple strategy which reduces the medium price you pay over time.

The strategy is known as “dollar cost averaging”. Basically, it consists in investing the same amount of money in the fund regularly and with determined time frame (monthly, bimonthly, etc.).

First, you have to choose the most convenient interval, which you can afford. Your dollars can buy relatively less shares when the price is high and more when the price is low. The strategy “dollar cost averaging” doesn’t guarantee gains, but it increases the probability that the medium price you pay for your fund is lower than the average market price.

Let’s analyze an example: You are investing $200 in a mutual fund every 3 month and the price is $50 per share. When the price goes down, it is $25 per share. During the first trimester, $200 can buy 8 shares. During the second trimester, the price doesn’t recover and is still at $25. You can buy 8 shares more. At the end of the year the price goes back to $50 and you buy 4 more shares.

Here is what happened:

Invested Price Shares
$200       $50     4
$200       $25     8
$200       $25     8
$200       $50     4
$800       $150  24

You invested $800 during the first year and bought 24 shares of the fund; As the market price is $50 at the moment, your shares are worth $1,200 or $400 more than the price you paid for them. To find out the medium cost you have to divide the money you paid by the number of shares you are holding. The medium cost was thus $33 ($800/24).

Well, you might think that if the market price falls drastically in 1 year, you should sell your shares. The response is: “Don’t do this.” Mutual fund investing is always with a long-term perspective and you have to stick to your mutual fund especially in bad times, which might occur occasionally.

The strategy must be to continue to buy every 3 months the same amount of money. This is the most difficult part of the strategy “dollar cost averaging”, but the most important as well. On the long run, you can obtain your shares at a lower medium price when the market is depressed.

"You are free to choose, but the choices you make today will determine what you will have, be, and do in the future." - Zig Ziglar
 

 

 

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