Proven Methods to Consider when Investing

When it comes to successful investing, there really is no one proven method that consistently works wonders in the short term.. If there were such a method, then all of us would be millionaires. However, there are several methods of investing that can significantly lower the overall risk of investing and increase the probability of a higher return over the longer-term. Here are some of these methods:

Dollar Cost Averaging

Dollar cost averaging is a method that reduces market risk by systematizing the purchase of securities. With this method, an investor invests a pre-determined amount of money into a security at regular intervals. Instead of buying a huge amount of the asset all at once, an investor slowly and steadily buys smaller amounts of the asset over an extended period of time. The real purpose behind dollar cost averaging is to spread out the cost basis of the investment over many years, which creates an insulation against fluctuations in the market price. With dollar cost averaging, you are rarely going to be buying a stock right at its peak or its all-time low.

To set up a dollar cost averaging plan, an investor has to do three basic things. First, he has to decide exactly how much money he can afford to invest every month. Second, he must choose the investment that he would like to hold over the longer-term (5 to 10 years). And third, he must regularly invest the pre-determined amount of money into the security he has selected. Typically, a broker will set up such a plan for an investor with an automatic withdrawal.

Reinvesting Dividends

Normally, dividends on stocks are paid out in cash. But many companies also offer their investors dividend reinvestment plans (DRIPS) which automatically reinvest the dividends in more shares of the company’s stock. There are several benefits associated with this investment practice. First, you can compound the returns on your original dividends over the longer term because you are given more shares of the stock. In other words, your shares are worth more when the stock price goes up and you are also earning extra dividends on the original dividends you invested. Second, much like with dollar cost averaging, you can insulate yourself relatively well from price fluctuations because dividends are usually paid out at regular intervals. You gain more shares when the stock price is low and fewer shares when the stock price is high, but your average purchasing price for the stock will not reflect any peaks or troughs. Third, many companies offer their stock at a discount from the market spot price (1%-10%) when an investor chooses to participate in a DRIP, which essentially lowers the cost of investment.

Diversification

Diversification is another well-established method of protecting an investor from the ups and downs of the market. Since 1929, the stock market has averaged an annual return of 10%. Yet, in all that time, more than a few companies have gone out of business. With diversification, an investor holds a portfolio that is comprised of many different individual stocks. The goal here is to prevent any one stock from determining the success or failure of the investor’s overall investment plan.

One of the most common ways of diversifying a portfolio is to invest in mutual funds. Mutual funds already hold stock in a large number of securities, so they are seen as a very easy way of reducing risk. However, most mutual funds will also focus on a certain segment of the market, depending on what their investment objectives are. An investor who truly wants to diversify his portfolio may want to look into investing in a range of mutual funds that each focus on different market segments or asset classes.

The type of investment method that an investor chooses to follow will always depend on his personal preferences and risk appetite. There is no fool-proof guarantee that you will earn a return on your investments if you are in it for the short term. And while there is also no “best way” of investing your money over the longer-term, the above-mentioned methods have been proven to substantially protect investors from market risk and help secure a healthy rate of return on their investments. 

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