Recs

12

What If the Market Goes Nowhere?

Over the past 10 years, the S&P 500 index has been essentially flat. After closing at 1,164.33 on July 10, 1998, it closed at 1,239.49 on July 11, 2008. That's a whopping 6.5% return in a decade, or all of 0.63% annualized.

Of course, it wasn't exactly a straightforward walk in the park. The decade included such market events as:

  • The dot-com bubble.
  • The bursting of the dot-com bubble.
  • The aftermath of Sept. 11, 2001.
  • The housing bubble.
  • The subprime mortgage meltdown and resulting financial crisis.
  • The impact of skyrocketing oil costs.

Considering the roller-coaster ride of volatility you went through to get that 0.63% annual return, it hardly seems like it was worth the trouble.

It wasn't quite that bad
Although the market was essentially flat, your returns didn't have to be. Instead of a 0.63% annualized return, you could have earned a 2.29% rate of return. Instead of winding up with 6.5% more than you started with, you could have wound up with 12.2% more -- all while being invested in an index fund.

How? Two things:

  • Making regular investments once a month over that same period.
  • Reinvesting your dividends along the way.

It's still a far cry from the market's historical 10% long-term rates of return, but it illustrates the long-term power of two of the market's most overlooked forces: dollar-cost averaging and dividend reinvestment.

First, invest regularly
Dollar-cost averaging -- making regular investments of the same amount of money in the same stock or index fund -- takes advantage of market volatility to make your money do more work for you.

After all, every time you buy stock, you turn over your cash for shares. The lower the price of those shares, the more of them you get for your money. And when it comes time to tally up your totals, each of those cheap shares counts for just as much as the ones you bought at higher prices.

Let's say you decided to buy $500 worth of an index fund every year:

Date

Cost per Share

Amount Invested

Number of Shares Bought

7/10/2005

$100.00

$500.00

5.00

7/10/2006

$200.00

$500.00

2.50

7/10/2007

$50.00

$500.00

10.00

7/10/2008

$100.00

$500.00

5.00

Total

$88.89

$2,000.00

22.50

The stock wound up exactly where it started, but your $2,000 investment turned into $2,250 -- thanks to the power of those cheaper shares.

Second, invest regularly
Once you add dividend reinvestment to the mix, the picture gets even brighter. If, every year, the stock throws off a $2.00 dividend, the numbers look like this:

Date

Cost per Share

Amount Invested

Amount From Dividends

Number of Shares Bought

7/10/2005

$100.00

$500.00

$0.00

5.00

7/10/2006

$200.00

$500.00

$10.00

2.55

7/10/2007

$50.00

$500.00

$15.10

10.30

7/10/2008

$100.00

$500.00

$35.70

5.36

Total

$88.79

$2,000.00

$60.80

23.21

Thanks to those dividends, that same $2,000 is now worth $2,320.90 -- in spite of the fact that the index wound up exactly where it started.

Now's a great time to start
The combination of dollar-cost averaging and dividend reinvestment will earn you a better return in the real world than simply buying and holding -- and that's especially true in a market as volatile as this one.

Thanks to the recent market meltdown, many stocks are trading substantially below their 52-week highs -- meaning you can snap up more shares for the same investment.

Company

Recent Price

52-Week High

Industry

Goodyear (NYSE: GT  )

$16.98

$36.67

Rubber & Plastics

Terex (NYSE: TEX  )

$43.59

$96.94

Farm & Construction Machinery

Allstate (NYSE: ALL  )

$44.15

$61.22

Property & Casualty Insurance

Valero (NYSE: VLO  )

$32.63

$78.09

Oil & Gas Refining & Marketing

Wyndham Worldwide (NYSE: WYN  )

$15.75

$38.73

Lodging

WellPoint (NYSE: WLP  )

$44.87

$90.00

Health-Care Plans

Macy's (NYSE: M  )

$15.58

$45.50

Department Stores

Data from Yahoo! Finance.

If you're not already dollar-cost averaging and reinvesting your dividends, this is the time to start.

Foolish final thoughts
The market may have been flat over the past 10 years, but the difference between a 0.63% rate of return and a 2.29% rate of return is significant -- especially in your retirement portfolio, where it will compound with all of the rates of return to come.

At Motley Fool Rule Your Retirement, we urge subscribers to make full use of the power of dollar-cost averaging and dividend reinvestment. In times like these, they are key strategies for securing a better long-term future.

If you'd like to read about other key strategies for creating a comfortable retirement, join us for a 30-day free trial of Rule Your Retirement today. Click here to get started.

At the time of publication, Fool contributor Chuck Saletta owned shares of Wyndham Worldwide. WellPoint is a Motley Fool Inside Value pick. The Fool owns shares of Terex. The Fool's disclosure policy always reinvests its dividends.


Read/Post Comments (3) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 14, 2008, at 5:27 PM, SoleInvestor wrote:

    Great article, it is really important to be aware of how your purchasing power can grow, even if it is a slight growth during crazy market times, it still grows over time in your favor and especially during bull runs.

  • Report this Comment On July 15, 2008, at 12:51 PM, kwill10 wrote:

    I hear everyone lamenting the misery of the market; I think a founder of Minyanville even announced he had all of his investments in cash the other day. It's nice to see some balance to counteract the panic that seems a bit media-induced.

  • Report this Comment On July 15, 2008, at 2:32 PM, sanj49 wrote:

    The logic of dollar-cost averaging escapes me if the market was flat for past 10 years. Stocks as an asset class seem to be over-sold. Time to look at other wealth building assets.

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Chuck Saletta
TMFBigFrog

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy, and he manages the real-money Inflation-Protected Income Growth portfolio on Fool.com based on many of Graham's principles. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.

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