A while back, I read Alice Schroeder's biography of Warren Buffett, The Snowball. Afterward, I was pleased to run across a video clip of her discussing Buffett and the book. There was one thing she said, though, that surprised me.
She noted that Buffett never advocated dollar-cost averaging, something she thought of as a good thing for investors to do, because you should never buy the market without taking price into account.
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 a broad-market 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 outperform 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 many investors end up doing during bull markets.
If you're looking for investments that track an index, there are all sorts of funds to choose from:
- The Nasdaq 100 includes the top nonfinancial firms that trade on the Nasdaq stock exchange. Some of them, including Apple
(NASDAQ:AAPL)and Microsoft (NASDAQ:MSFT), are truly huge. Others, such as Foster Wheeler (NASDAQ:FWLT)and Patterson (NASDAQ:PDCO), aren't large caps at all.
- If you like small- and mid-cap companies, then the Russell 2000 Index holds thousands of them, including E*TRADE Financial
(NASDAQ:ETFC)and UAL (NASDAQ:UAUA).
- You can invest even more broadly and add stocks such as GlaxoSmithKline
(NYSE:GSK)with an international index fund.
If you want to learn how to weave all these and other sorts of funds into an asset allocation you can live with, turn to our Motley Fool Rule Your Retirement newsletter service, 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. Apple is a Motley Fool Stock Advisor selection. Motley Fool Options has recommended a diagonal call position on Microsoft, which is a Motley Fool Inside Value pick. The Fool owns shares of GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.