Effective Investment Strategies
Reinvestment of Dividends
If you purchase stock that pays a dividend, some companies allow you to automatically purchase additional shares of stock with the dividend. Dividends paid by the stocks that a mutual fund holds are distributed to the fund’s shareholders. The dividends of any stock within a mutual fund are usually reinvested automatically into the fund, unless you request otherwise. Reinvesting dividends allows you to buy more shares in that fund without incurring a sales charge. Many, but not all, companies allow you to automatically purchase additional shares of stock with the dividends that are paid out to shareholders each year.
Diversification means that you purchase a variety of investments. Diversification may reduce risk because your assets are not dependent on the performance of any one stock. The ability to diversify your investments easily and affordably is one of the major benefits of mutual fund investing. By purchasing shares in a mutual fund, your investment dollars are spread over a number of stocks. That’s important and wise. You might want to diversify even further by investing in more than one mutual fund and look for funds that invest in different sectors of the market.
It’s a question every investor faces – How do I pursue growth opportunities while managing risk? One way to strike a balance between potential gain and possible loss is to diversify among several investment categories such as stocks, bonds, and cash. This process is called asset allocation. Asset classes have different characteristics and may perform differently in different economic conditions. The goal of asset allocation is to help you meet your financial objectives by achieving the highest returns over time without taking more risk than you can accept.
For long-term investment goals, systematic investing can be one of the best ways to build wealth. Many mutual fund companies allow you to set up a systematic investment plan (SIP) whereby you can contribute low minimum amounts through regularly-scheduled electronic fund transfers from your checking or savings account.
Use our How to be a Millionaire Calculator to see how systematic saving and investing can help you achieve your goals.
Dollar Cost Averaging
When you use systematic investing, you also obtain the benefits of dollar cost averaging. This disciplined investment approach involves investing a specific amount of money on a regular basis. By investing the same amount at a regular interval, you will purchase more shares when prices are low and fewer shares when prices are high. Overall, that means you may pay a lower average price for each share you own. You don’t need to try to predict when the markets will go up or down. Over time, this strategy may increase the value of your investments.
Dollar cost averaging does not assume a profit or protect against a loss in declining markets. Because dollar cost averaging involves continuous investment in securities regardless of fluctuating price levels, investors should consider their attitude about additional stock purchases when the price is falling or going higher.
When you invest money in the stock market, you assume the risk of market fluctuation – the value of your investments may go up or down, and you may lose money, or earn more or less than you planned. Many factors influence a person’s tolerance for risk. For example, your personality plays a part – some people want higher returns, and those involve more risk than conservative investments that have slower growth or earnings. In another example, when saving for retirement, a younger person has time to recover from potential market losses, whereas someone nearer to retirement has less time to recoup potential losses. So time is a risk variable. Another risk is “putting all your eggs in one basket” – investing all your money in one stock rather than spreading your investment across several stocks, as with a mutual fund.