Dollar Cost Averaging Can Be an Effective Strategy

You may have heard of dollar cost averaging, which is the process of making small investments at regular intervals over time. But have you tried it? You may find it worthwhile because it can be an effective investment strategy.

Dollar cost averaging establishes discipline; you build a habit of regular investment to help you reach your long-term goals. And by investing regularly over time, you’re not worried about trying to time the market.

In fact, it can help you take advantage of market fluctuations. Because you invest the same dollar amount each period, you typically purchase more shares when prices are low and fewer shares when prices are high. This means that over the entire purchase period, your average cost per share could be lower than the investment’s average price per share.

Dollar cost averaging works for just about any type of investor with any amount of money to invest. If you don’t have much to invest, dollar cost averaging can be a great way to ease into investing because you can start with a relatively small amount of money.

On the other hand, if you have a large sum to invest (such as an inheritance or proceeds from the sale of a home), you can put it into a savings or money market account, then move small portions into a stock or bond mutual fund over time.

Of course, deciding whether to use a dollar cost averaging strategy depends on your individual financial situation.

Your advisor can help you make the right choice.

Consider Bond Durations to Help Manage Risk

The volatility of the current market has driven some investors out of stocks and into bonds, which are often perceived to be less risky.

But bonds also have risks – most notably, interest-rate risk. This risk, however, can be managed if you understand the concept of duration.

Generally speaking, bond prices move in the opposite direction of interest rates. Higher interest rates drive bond prices down and vice versa. The risk that your bond price will fall because interest rates rise is called interest-rate risk.

When purchasing shares of a bond fund, you can help manage interest-rate risk by paying attention to the fund’s duration. Duration is a number that indicates the percentage change in the price of a bond fund for each 1% change in the interest rate.

For example, if the bonds in a particular fund have an average duration of three years, for each 1% change in interest rates, the bond fund’s price should move 3% in the opposite direction of the interest-rate change. The lower the average duration of a bond fund, the less price sensitivity the bond should experience.

What does this mean for you?

If you are a risk-averse investor, you may want to consider bond funds with shorter durations. In the event that interest rates rise (and prices drop), you don’t want to be “locked in” to bonds that don’t mature for several years. With rising interest rates, bonds with longer durations will actually be worth less than newly purchased bonds.

If, however, you purchase faster-maturing bonds – those with shorter durations – you’ll be able to replace the lower-price bonds as they mature.

Many investors are concerned about what to invest in given the volatile market.

While bonds remain good investments, you can minimize the risk by understanding the concept of duration and making it work for your individual situation.

Using Retirement Assets for Emergencies Can Backfire

hen an emergency arises, it can be tempting to use some of the assets you’ve built up in your retirement plan, but before you do so, ensure that you’re aware of some of the consequences. Below we outline just a few:

Traditional IRAs: All withdrawals of tax-deductible contributions and all earnings are taxed as ordinary income. Generally, any withdrawals made before you reach 59½ years old are also subject to a 10% early-withdrawal penalty.

Roth IRAs: Because contributions and conversion amounts have already been taxed as ordinary income, no additional tax or penalty is due. However, any withdrawals of earnings made before you reach 59½ years old may be subject to a 10% early-withdrawal penalty unless an exception applies. Withdrawals of earnings may be tax-free if five years have passed since your first contribution or conversion, and if the withdrawal is made for a qualifying reason.

Education IRAs: Withdrawals generally are made for qualifying educational expenses, and there are no provisions for hardship. So education IRAs generally cannot be tapped for emergencies without taxes or penalties.

401(k) Plans: After-tax contributions may be withdrawn for any reason, but earnings on these amounts are taxable and generally subject to a 10% penalty if you are younger than 59½ years old. You may be able to withdraw pretax contributions early if you demonstrate financial hardship. This could include forestalling eviction or foreclosure on your primary residence; paying college tuition for yourself or your dependents; paying medical expenses not covered by your insurance; or purchasing a home. The distribution is subject to federal tax withholding and is taxable in the year of the withdrawal. Plus, if you’re younger than 59½ years old, the withdrawal is generally subject to a 10% penalty.

The tax and legal information in this article is merely a summary of our understanding and interpretation of some of the current laws and regulations and is not exhaustive. Investors should consult their legal or tax counsel for advice and information concerning their particular circumstances.

Avoid Lost Payouts: Learn the Rules of Inherited IRAs

An inherited Individual Retirement Account is not a unique product; it’s simply an IRA inherited from a deceased family member.

Under current regulations, people who have inherited IRAs can stretch their withdrawals across their own lifetime. That means the assets could potentially increase in value, tax-deferred, for decades. Despite that, many families unknowingly cash in the account, losing the possibility of a later payout. And there’s no way to get the money back into the IRA after it’s been cashed out.

If you inherit an IRA, it’s important not to do anything until you know what rules apply. It’s not like your own IRA, from which you can withdraw money and redeposit it in another IRA within 60 days without penalty. With an inherited IRA, all movement of money must be from one IRA custodian to another – a “trustee to trustee” transfer. Note that it’s always wise to check everything received from the custodian to avoid misunderstandings later.

Unless you’ve inherited the IRA from a spouse, you must retitle it yourself; don’t count on the custodian’s forms to do it for you. The original owner’s name must be included. For example, it could be titled “John Doe, deceased (date of death), inherited IRA for the benefit of Jane Doe Smith, beneficiary.” If two or more people are named as beneficiaries, you should ask the custodian to split it into separate IRAs. That avoids investment squabbles and allows younger heirs to stretch out withdrawals over a longer period.

The tax and legal information in this article is merely a summary of our understanding and interpretation of some of the current laws and regulations and is not exhaustive. Investors should consult their legal or tax counsel for advice and information concerning their particular circumstances.


Should You Compare Your Own Funds to the S&P 500 and DJIA?

For many investors, a high-performance fund is one that zooms ahead of the market. But what is the market?

As a pacesetter for their funds, investors often turn to the performance of a widely used index such as the Dow Jones Industrial Average – the average value of 30 large industrial stocks – or perhaps the S&P 500 index, which includes stocks from 500 leading companies in leading industries. However, these indices aren’t the market and may not be relevant for the individual investor.

Consider the S&P 500 index. Even though the equities are chosen to represent the U.S. economy, the list isn’t comprehensive. There are more than 5,000 stocks listed on the New York Stock Exchange and the S&P actually tracks only a small percentage of these.

Moreover, the S&P 500 is made up of essentially one asset class: large-capitalization companies. So, if your fund contains small-capitalization stocks, the S&P 500 might not be an accurate gauge of its performance.

In fact, the S&P 500 index isn’t always an accurate gauge even for funds that consist mainly of large-capitalization companies, because it isn’t equally weighted. The largest and often most popular stocks account for the majority of the index’s performance. These popular stocks have a weighting several hundred times that of the less popular stocks.

That doesn’t mean you should ignore the S&P 500 and other indices.

However, to use an index as a pacesetter, you might want to ascertain whether its securities are comparable to those in your fund’s portfolio.

Four Tips to Help You Manage Market Volatility

As a result of the stock market’s decline during the financial crisis, many investors now worry that even minor downturns are warnings of worse times ahead.

No one can predict when or by how much a security’s value will fluctuate, but you can take steps to protect your portfolio from market volatility.

First, don’t try to time the market. Some investors try to overcome market volatility by jumping in on an upswing and jumping out on a downswing. But even the pros find it difficult – if not impossible – to predict how financial markets will react.

Remember, you have to be right twice: when you sell and when you buy.

Review your asset allocation before you’re tempted to make emotional changes.

Make sure your portfolio is diversified. Although diversification can’t protect you from a loss, it may help cushion your overall portfolio from significant declines.

If you’re still contributing to an account, you may want to invest a fixed amount a little at a time instead of a lump sum all at once.

This strategy for managing risk is called dollar cost averaging.

Because the amount you invest remains constant, you are able to buy more shares of a stock or mutual fund when the price is low and fewer shares as the price rises. Over the entire purchase period, your average cost per share could be lower than the investment’s average price per share.

Stick it out. Although past performance is no guarantee of future results, historically the markets have always rebounded. For the past 10 years ending December 31, 2011, the S&P 500 index gained over the long term, returning 2.92%.

(Note that the S&P 500’s return factors in dividends and is thus higher than it would be without dividends. It is not possible to invest in an index.)

This Summer Kick-Start Your Teen’s Retirement Fund

For many teenagers, summer means a chance to earn extra cash – but earning money also means he or she can open an individual retirement account (IRA).

Minors who have reached age 14 and have earned income are eligible to open a traditional or Roth IRA. Traditional IRAs allow contributions to grow tax deferred until retirement, and contributions may be tax-deductible. In contrast, contributions to Roth IRAs are always taxable, but withdrawals made after age 59½ can be tax free.

Early start makes a difference

When it comes to investing, an early start can make a big difference. As an example, let’s assume 16-year-old Angela earns $2,500 from her summer job at the mall. She or her parents can deposit $2,000 in a Roth IRA in Angela’s name. Suppose that money is left untouched for 50 years, until Angela retires at age 66, and the investment grows at a hypothetical rate of 10% each year. Angela could have more than $230,000 in her Roth IRA – money that could be distributed tax free.

Not interested? You can still help

Teens being teens, you may find that he or she would prefer to spend the money rather than invest it.

So, while you may want to encourage your teenage child or grandchild to invest some of his or her hard-earned money in an IRA instead of spending it—if the teen doesn’t want to contribute, you can fund an IRA contribution for him or her.

Doing so will give your teen an invaluable kick-start on life.

Interest Rate Sensitive? Think Short Term

Do you want to stay in the fixed-income market but are afraid that a rise in interest rates might erode bond prices? A short-term bond fund may be a good investment vehicle for you.

When interest rates fall

First, let’s examine how interest rates affect individual bonds. Say interest rates are falling. If you buy a $10,000 bond when interest rates are at 8%, your bond yields 8%, or $800, annually.

Now let’s assume that after you purchase that bond, interest rates fall to 7%. A newly purchased $10,000 bond yields $700 annually. Because your existing bond pays $100 more a year, it is more valuable, and its price will tend to rise.

When interest rates rise

In contrast, when interest rates rise, bond prices fall. If you buy a $10,000 bond at 8%, your bond yields 8%, or $800, annually. Now let’s assume interest rates rise to 9%. A newly purchased $10,000 bond yields $900 annually. Because your existing bond pays $100 less a year, it is less valuable and its price will tend to fall.

Bond funds

The same holds true for bond funds ,which are simply portfolios of individual bonds and behave the same way.

When today’s historically low interest rates begin to rise and bond values fall,

you don’t want to be “locked in” to bonds that don’t mature for years, because they will be worth less than newly purchased bonds.

Consider short-term funds

So, how can you protect your bond fund against a possible rise in rates? You could switch to a portfolio of bonds with shorter maturities – a short-term bond fund. If you purchase faster-maturing bonds, you’ll be able to replace lower-price bonds as they mature. You can do this yourself by purchasing individual bonds, or you can purchase shares of a short-term bond fund. To decide what’s best for you, explore your options with your financial advisor.

Is the Bloom off U.S. Treasury Bonds?

U.S. Treasury bonds rallied in 2011, as a number of macroeconomic woes, including the European debt crisis, incited worries of a global market meltdown. Does that mean you should consider investing in them?

Yes, U.S. Treasuries are appealing. A portfolio of U.S. Treasuries with an average maturity of 20 years rose 28% in 2011, even better than its 26% jump in 2008, when we were in the midst of a financial crisis. The government securities haven’t seen a better year since 1995, according to Morningstar.

That doesn’t mean U.S. Treasuries are a sure thing. No investment is.

The U.S. Treasury rally could wind down at any moment. In order to match the 2011 price rally, the 10-year U.S. Treasury yield would have to drop to about 1.05%, far below its record low of 1.72% in September 2011.

Additionally, there are other high-yielding alternatives. For example, you may be able to obtain higher yields with only slightly more volatility via non-Treasury government-backed bonds such as those issued by agencies or supported by agency mortgage-backed securities.

One example is mortgage-backed securities supported by the Government National Mortgage Association, which guarantees investments backed by federally insured loans.

These securities carry the full faith and credit of the U.S. government and may offer a higher yield than comparable U.S. Treasuries.

Another example is a bond from less-well-known government agencies such as the Federal Farm Credit, the Tennessee Valley Authority and the Federal Judiciary Office Building Trust. As of mid-January, these 10-year bonds yielded about 2.6%, 0.6 percentage points more than the equivalent U.S. Treasury, according to The Wall Street Journal.

Of course, no investment is necessarily suitable for all investors. Contact your financial advisor for help in determining if the securities mentioned here are appropriate for your portfolio.

Factor Investing: Is It the Right Strategy for You?

The European debt crisis that arose late last year and has continued since is putting the best-laid investing plans to the test. The reason? Correlation.

Correlation refers to how securities or asset classes perform in relation to each other and/or the market. A 1.0 correlation indicates that two security types move in exactly the same direction. A -1.0 correlation indicates movement in exactly opposite directions. A zero correlation implies no relationship.

Last year, the correlation between the stocks in the S&P 500 index and the index itself went from as low as 0.4 in February to as high as 0.86 in October, according to Birinyi Associates.

That level of correlation can make the diversification you’ve worked so hard to create in your portfolio ineffective. Never fear, though. One option for addressing highly correlated markets like today’s is factor investing.

Factor investing replaces traditional asset allocation with a focus on specific attributes that researchers say drive returns. These factors can include familiar attributes, such as small-cap or dividend yield. They can also include more complex attributes, such as economic sensitivity and volatility.

To utilize factor investing, you would look at your current factor exposure. To simplify things, you may want to consider just a few factors – such as the three most researchers agree on, which are beta, size and style. Next, decide whether that’s appropriate. Finally, tilt your portfolio toward the factors you think will outperform.

Factor investing isn’t new. It originated in academia 20 years ago, and now is finding favor among institutional investors.