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Dollar-cost averaging

(123Jump via COMTEX) -- For those of you who were smart enough to set up a dollar-cost averaging plan in your investment or retirement accounts -- Bravo! Continue doing what you are doing -- this column is old news to you.

While we wait for the dollar-cost averagers to hit the back button and exit out of this article, those of you who remain will be happy to learn that you have not missed the boat.... you really haven't.

Four consecutive gains for the Nasdaq last week? A 14.01% gain for the tech-laden index for the week? No, you still haven't missed the boat.

Too Early for a Bottom

Despite the bulls' aggressive move last week, the current economic environment does not support a sustainable rally -- at least not yet anyway.

As noted in a previous article, the underlying rationale is that the economy remains weak and consumers continue to rein in their spending. This decrease in spending results in lower revenues for corporations that sell goods and services, ultimately leading to lower earnings.

As evidenced by the share value reaction of companies such as Cisco Systems Corp. (CSCO) and JDS Uniphase Corp. (JDSU) after earnings announcements, how much a company makes and is projected to make is the primary driver behind the firm's share value.

Consequently, given a weak economic picture, business across the board is likely to report poor quarterly earnings. Furthermore, given that the economic picture does not appear to be recovering appreciably, it is likely that lower-than expected earnings will continue for at least another quarter.

This will undoubtedly drag share values even lower than where they sit today. A level where over-enthusiastic retail investors artificially support technology company share values with "I-don't-want-to-miss-the-rally" buying. These are exactly the type of investor that the institutional hedge fund managers have burnt with shorts over the past few months.

L-Shaped Recovery Likely

The above being said, a diligent analyst should also provide the caveat that there isn't much more room for technology to the downside -- at least on a psychological level.

Many companies like Sun Microsystems (SUNW) have share values trading in the teens. Far lower than the lofty plus-$100 highs that were commonplace for tech-sector stocks. However, given much-lower valuations, many investors will begin to believe that these companies are now becoming value plays. Thereby setting up rallies like the one experienced last week.

What these investors should take into account, however, is the fact that many of these stocks -- that are now trading at reduced price ranges from a year ago -- have split at least once over the past few years and often more than once.

Therefore, since there is relatively little downward room for stock movement and low earnings will prevent sustainable upward momentum, it is likely that the market will trade sideways over the next few months -- creating an L-Shaped recovery.

How do I Catch the Bottom?

First, let's get this straight; it is impossible to "catch" the bottom. If an investor can capture the absolute lowest point for a security prior to a rally, that investor is lucky -- period. The best an investor can reasonably expect is to get in as close to the bottom as possible. The best way to achieve this, without the benefit of luck or divine intervention, is dollar-cost averaging.

Dollar-cost averaging is an investment style that purchases units of an investment at different price points over time. In doing so, the investor's total cost of investment is averaged out, thereby eliminating the inexact science of market timing.

That being said, the current environment lends itself perfectly to dollar-cost averaging given the market's volatility. Furthermore, given the likelihood that the worst of the declines are over (see above, re: not much room left to maneuver), dollar-cost averaging will capture an excellent low average price.

In the example for mutual fund XYZ, an investor who regularly invests each month during the decline and rise of the fund's net asset value per share (NAVPS), will capture an average cost of $7.50. Since the fund at the end of December is sitting at $10, the investor makes a $2.50 per share average profit. This is far better than a lump sum investment at $10 at the beginning of the year in January, since he/she would only break even at the end of the year.

As the investing adage goes, "the best time to start is now." Given the current investing climate, this axiom is likely as true as it will ever be in terms of dollar-cost averaging.

(c) 2001 123Jump

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