Profit On Turmoil

By Daniel Kadlec

These are nutty days on Wall Street, and you can hardly be blamed for thinking about shifting your investments into something safe, like a money-market fund--if not the mattress. The esteemed Warren Buffett revealed last Monday that he had recently sold more than $5 billion in bonds. Presumably, that money is now parked somewhere secure while he hunts for bargains--if he hasn't already found them in the wake of last Tuesday's stock-market dive. Bully for him. But remember that he's a billionaire investment god. Mere mortals don't have his eye for value, nor can they easily summon the discipline to "buy the dips" in volatile times like these.

The Dow, which last week had fallen as much as 10% from its high, could fall further and seriously set back anyone who plows in a pile of money now. But a happy irony of the stock market is that the nuttier it gets, the more you can make by sticking to a regimen of investing a set amount at regular intervals, as most folks do with their 401(k)s or other automatic-investment accounts. That's right: when stock prices fly up and down in dramatic fashion, it's to your advantage. The hard part is gutting out those unnerving price declines. But if you leave your automatic-investing program in place, the payoff will make you feel a lot smarter than friends who try to time the market's zigs and zags.

Consider a stock or mutual fund in which you invest $100 a month at a starting price of $20 a share. After one month, the price is $25, a month after that $10, then $30, $15 and, finally, right back at $20, where it stays for a month. No gain after six months, you say? True, the stock is where it was when you started buying: $20. But because you invested $100 each month, you would have accumulated 34 shares at an average price of just $17.65, and be up by the annual equivalent of 27%. That's the magic of steady investing, also known as "dollar-cost averaging." You automatically buy more shares when prices are low and fewer when they are high, driving down your average cost per share.

What's more, the bigger the price swings are, the better off you'll be. Mark Riepe, who heads the Charles Schwab Center for Investment Research, is putting the final touches on a new study that looks at extreme price fluctuations. He has found that when the average monthly movement of a stock--up or down--doubles, steady investors enjoy a 7% greater return over just two months. "What really makes it work is that the stock market goes up over time," he says. But even in a market whose average is flat for a time, wilder price gyrations lead to better overall returns. For that reason, dollar-cost averagers are better off in volatile investments, such as index funds and technology stocks.

There is ample evidence that what works even better than dollar-cost averaging is simply plunking all your long-term savings into stocks as soon as you can, regardless of the market's level. More time in the market means there's a better chance that your money will be there for a rally. But for a big one-time windfall, like an inheritance or annual bonus, I'm not convinced that's a sound strategy psychologically. The trauma of watching the market tank a week after putting everything in stocks would be too great. I'd rather make market volatility my friend. By steadily investing the same amount each month, I know I am buying stocks as cheaply as possible--at least, that is, for a mere mortal.

See time.com/personal for more on market swings. E-mail Dan at [email protected] See him Tues., 12:40 p.m. E.T., on CNNfn.