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Do This and You'll Never Miss Another Rally

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Looking over the past year, many investors are beating themselves over the head at having missed the golden opportunity for big profits in the stock market. Yet, while it's completely unrealistic to expect to pick a market bottom perfectly, there's no good excuse for not enjoying a large part of the market's gains since the March 2009 lows.

Heads I win, tails you lose
Too many people focus their efforts on making stock purchases at exactly the right time. It's easy to understand why. There's nothing more disconcerting than buying a stock only to see it immediately drop in value. No matter how strongly you feel about the reasoning behind buying that stock, you'll be tempted to worry that the market knows something bad about the company that you somehow missed -- and unless you have a lot of discipline, you may end up selling out at a loss just before the stock takes off.

Think back to the first phase of the market meltdown back in the fall of 2008, when the market dropped steadily through late November. For a while, it looked like the November lows would mark the low-water point for stocks. But after a brief rally, pessimism took control again -- and the S&P 500 fell another 10% before bottoming out.

By itself, being hesitant to buy while stocks are falling isn't a fatal flaw in an investing strategy. The problem is that most investors then hesitate to buy once the market starts to recover. If you miss the bottom yet refuse to pay slightly higher prices for fear that the downturn will resume, then you'll never end up buying stocks.

Buy a little bit
One solution that many investors use is to buy a little bit of stock at a time over the course of several months, or even years. The strategy is a compromise between the huge potential returns that perfect timing can bring and the fear that bad timing will create huge losses.

As an example, say that you had $40,000 to invest in stocks at the beginning of 2009. You could have put it all to work right away, but you weren't sure whether the timing was right. So instead, you split it into four equal chunks, investing $10,000 on the first trading day of January, and then putting the rest in at the end of March, June, and September.

As things turned out, you were early with your first purchase, just about perfectly timed on the second, and late on the final two installments. Yet overall, you would have had a return slightly better than investing everything all at once at the beginning of the year -- and without the same level of worry you would have had from taking that big risk.

It's interesting to take a look at how the strategy worked during 2009 with a variety of stocks, including a wide swath of big winners, solid stalwarts, and large losers:

Stock

Total Return From One-Time Investment

Total Return From Quarterly Purchases

Ford (NYSE: F  )

411%

243%

Sirius XM Radio (Nasdaq: SIRI  )

692%

258%

Johnson & Johnson (NYSE: JNJ  )

12%

17%

Coca-Cola (NYSE: KO  )

22%

16%

Wal-Mart (NYSE: WMT  )

(1%)

9%

Citigroup (NYSE: C  )

(39%)

18%

MetroPCS (NYSE: PCS  )

(52%)

(45%)

Source: Yahoo! Finance.

As you can see, the results were somewhat mixed. For the truly stellar performers, you would have done better getting your money in as early as possible. Yet even those who waited still enjoyed good returns -- in part because at least some of their money got in at what proved to be the perfect time.

Meanwhile, on more mediocre performers, divying up your investment worked better. In several cases, you ended up outperforming a single investment, and those results came with a lot less volatility than you would have had being fully invested all along.

Know yourself
Investing a bit at a time won't always be the best strategy from a pure profit perspective. In the midst of a bull market, you'll typically underperform someone who puts all their money in at the outset.

But what you lose in raw profits, you'll gain in the psychological benefits of hedging your bets. By ensuring that you'll never again have to deal with having the worst timing in the world, you're more likely to stick to your guns and hold onto your best investment ideas through thick and thin.

If you're in the market for great stocks, look no further. Fool contributor Todd Wenning has some stocks you need to know.

Attention, Fools! Looking for a trustworthy financial planner? The Garrett Planning Network is offering a limited-time 10% discount for new Motley Fool clients. Just click this link, search your state, and look for the Motley Fool icon to identify participating advisors.

Fool contributor Dan Caplinger loves simple strategies. He doesn't own shares of the companies mentioned in this article. Coca-Cola and Wal-Mart are Motley Fool Inside Value picks. Ford is a Motley Fool Stock Advisor recommendation. Johnson & Johnson and Coca-Cola are Motley Fool Income Investor recommendations. Motley Fool Options has recommended buying calls on Johnson & Johnson. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is in rally mode.


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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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8/22/2014 3:22 PM
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