Never Dollar-Cost Average?

I'm in the middle of a very good book -- Alice Schroeder's biography of Warren Buffett, The Snowball. So I was pleased to run across a video clip of her discussing the book and Mr. Buffett. There was one thing she said, though, that surprised me.

She noted that Buffett never advocated dollar-cost averaging, something she opined as very smart, because you should never buy the market at any price. How interesting!

I've long been of two minds when it comes to dollar-cost averaging into individual stocks. I've supposed that it was a sound strategy in general, if you're regularly investing a set amount. But if you're just buying more shares of a stock as it falls, that can be dangerous -- like trying to catch a falling knife. Many times, when stocks fall, it's for a good reason.

But Schroeder was addressing the overall market, alluding to a strategy such as dollar-cost averaging into an S&P 500 index fund. I remember Buffett endorsing index funds on various occasions. In his 1996 letter to shareholders, for example, he said, "Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees." In 1993, he said what we at the Fool have long been saying: "By periodically investing in an index fund ... the know-nothing investor can actually out-perform most investment professionals."

Schroeder is right -- it can be silly to add money to the market when its value is way overblown. But many investors don't know when that is. If they just keep adding through good times and bad, they'll accumulate shares at a wide range of prices, and over time, their value will grow. They won't just be buying near the top, as often happens when bubbles develop.

If you're interested in index funds, learn more here. There are all sorts of funds to choose from:

• S&P 500 funds hold 500 big American companies, from the huge, such as ExxonMobil (NYSE: XOM) and General Electric (NYSE: GE), to the less huge, like Micron Technology (NYSE: MU) and Abercrombie & Fitch (NYSE: ANF).
• The Dow Jones Wilshire 5000 Index holds thousands of companies, including many medium-sized and small ones, such as Hospitality Properties Trust (NYSE: HPT) and Brocade Communications (Nasdaq: BRCD).
• You can invest even more broadly and add stocks like GlaxoSmithKline (NYSE: GSK) via an international index fund, such as the Vanguard Total International Stock Index Fund (VGTSX).

Happy indexing!