According to Alice Schroeder -- author of The Snowball, a recent biography of Warren Buffett -- the Oracle of Omaha has never been a fan of dollar-cost averaging. Though it's widely considered a useful strategy to help investors make prudent investments, Buffett reportedly believes that you should never blindly buy into the market, regardless of its price.
I've long been of two minds when it comes to dollar-cost averaging into individual stocks. It seems like 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, dollar-cost averaging can be as dangerous as trying to catch a falling knife. Remember, stocks often fall for good reason.
Still, there's something curious about Buffett's apparent condemnation of dollar-cost averaging. His criticism, as reported by Schroeder, seems to focus on broad-market investments such as index funds -- yet I remember Buffett endorsing index funds on various occasions. In his 1996 letter to shareholders, 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 echoed sentiments long shared by us Fools: "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 a stock has hit that peak. If they just keep adding through good times and bad, they'll accumulate shares at a wide range of prices, growing their value over time. They won't just be buying near the top, as often happens when bubbles develop, but during the highs, the lows, and everywhere in between.
If you're interested in index funds, you have plenty of choices:
- S&P 500 funds hold 500 big American companies, from the huge, such as Microsoft
(NASDAQ:MSFT)and AT&T (NYSE:T), to the less huge, like Akamai Technologies (NASDAQ:AKAM)and Wynn Resorts (NASDAQ:WYNN).
- The Russell 2000 Index holds thousands of smaller companies, including Palm
(NASDAQ:PALM)and Human Genome Sciences (NASDAQ:HGSI).
- You can invest even more broadly and add stocks like Total SA
(NYSE:TOT)via an international index fund.
If you want to learn how to weave all of these and other sorts of funds into an asset allocation you can live with, turn to our Motley Fool Rule Your Retirement newsletter, where you'll find a number of useful model portfolios to help guide you toward the best investments for you. By picking a good strategy and continually adding more savings to your portfolio, you'll increase your odds of investing success over the long haul.
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This article was originally published Dec. 30, 2008. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Akamai Technologies is a Motley Fool Rule Breakers pick. Microsoft is a Motley Fool Inside Value selection. Total SA is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool is Fools writing for Fools.