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Markets

How to Make Market Volatility Work For You

Diversify your holdings, don’t buy all at once, and be patient.

Investors are on edge. With such market volatility, is this the right time to be invested?

The answer is a categorical “Yes!” At times like these, investors tend to forget one of the first lessons they should have learned: Markets are cyclical. History has proven that the stock market rewards those who are in it for the long term.

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Before the year 2000, the stock market had not had a negative 10-year period since the 1930’s. Since 1950, there never has been a negative 20-year period. This is why long-term investors are wise to remember a quote from Warren Buffett, “The stock market is a device for transferring money from the impatient to the patient.

Historical evidence suggests that the longer investment horizons typically produce better results. In fact, annualized returns for S&P 500 Index using rolling monthly returns between 1950 and 2010 show the ideal holding period is 20 years.

But for short-term traders who attempt to “time” the market, the story is different. (And if you will have a short-term use for your resources, the outcome is also much less predictable.)

A market timing strategy subjects an investor to the risk of being out of the market when it soars. Why? No one can accurately and consistently predict the short-term direction of the market. Even the best of the market timers barely beat the averages.

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The lesson is clear: Long-term investors in stocks are rewarded. Sadly, however, many people are haunted by the fear that they will buy at the “wrong” time. As a result, they do nothing. There are three basic and easy-to-follow principles that make investing in equities a reasonable and worthwhile option, regardless of market conditions:

FIRST: Diversify your holdings. Invest in a wide range of industries and companies. Every asset carries some degree of risk. With a diversified portfolio, you protect yourself by minimizing that risk.

SECOND: Don’t buy all at once. Instead, use the time-tested technique known as dollar-cost averaging. Decide on a fixed dollar amount for each company, and invest on a regular, systematic basis. That way, you reduce the chance of buying all your shares at their tops. In fact, dollar-cost averaging guarantees that your investment will buy more shares when the price is low, and fewer shares when it is high. Since more shares are acquired at lower prices, your average cost will be lower than the average price of the stock during the period of your investment.

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THIRD: Remember that the current market price is only important when you actually sell. It doesn’t pay to try to out-guess or time the market. Even professionals don’t seem to be able to do that successfully. What pays is to stick with your long-term strategy. Better yet, market volatility is a good reason to fine-tune your long-term strategy to make the volatility work for you.

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There exists no better approach for the long-term accumulation of wealth safely and surely than this three-step plan: Build, via dollar-cost averaging, a diversified portfolio of high-quality U.S. stocks and stick with it.

The system is remarkably simple and effective and the results are dramatic. Yet only very wealthy investors regularly practice it.

Why? Because with a limited investment budget, it’s tough to achieve true diversification. Typically, people buy in round lots from a broker. Smaller investors may be limited to owning only a few companies, which limits diversification, and to buying their shares all at once, which prohibits dollar-cost averaging. If you tried to make small regular investments, commissions, even the tiny commissions charged by discount brokers, would eat up your profits even before you earned them.

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Of course, if you have substantial sums to invest, you can afford to buy a wide range of companies in “round lots” and the commissions you will pay on your initial investment and your routine continuing investments will be relatively small.

There is a solution for the smaller investor: Company-sponsored dividend reinvestment plans (or DRIPs) allow you to bypass the middlemen and invest directly in America’s top companies, often free of commissions or fees.

Which companies? Many of America’s highest-quality corporations offer DRIPs that permit optional cash investments. Among them: AFLAC, Kellogg, Exxon Mobil, Raytheon, Foot Locker, Northrup Grumman, and Abbott Labs. These companies and hundreds of others allow you to invest directly and without fees. Click here for a list of NO-FEE DRIP companies!

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Investing in DRIPs using this three-step strategy makes it possible to take advantage of another successful strategy that will tilt the odds further in your favor and reduce your market risk.

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You can supercharge the benefit of dollar-cost averaging by scheduling your investments just before the Ex-Dividend Date of the companies you’re investing in. If you own shares before the Ex-Dividend Date, the dividend belongs to you; if on or after the date, the seller is entitled to the dividend.

Companies publish their Record and Pay Dates and because trades take three days to settle, the Ex-Dividend Dates are always two business days before the Record Date, typically on a quarterly basis. You can maximize the value of your dollar-cost averaging strategy by making your regular investments just before the Ex-Dividend Date and receiving (and reinvesting0 each dividend about 30 days later…instead of up to 90 days (if you bought just one day late).

The following companies have Ex-Dividend Dates that are coming up shortly. To qualify for the Ex-Dividend Date, you need to be a shareholder. You can enroll in any of these DRIPs with the purchase of just 1 share of stock and set up the best schedule for earning the next dividend.

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  • Aqua America (WTR): One of the largest water utility companies, with 24 years of rising dividends
  • Dover Corporation (DOV): Industrial Manufacturer that has increased its dividend for 60 straight years
  • Illinois Tool Works (ITW): Industrial Systems producer with 40 consecutive years of dividend increases
  • NextEra Energy (NEE): Electric Utility and Energy Wholesaler with a leading position in wind power
  • Praxair (PX): Second largest provider of industrial gases and 22 straight years of dividend increases
  • Procter & Gamble (PG): Manufactures personal and household products, with 59 straight years of higher dividends
  • SCANA Corp. (SCG): Electric and gas utility in the Southeast; 15 consecutive years of dividend increases

Find the Ex-Dividend date of your favorite stocks here.

Ms. Vita Nelson is one of the earliest proponents of dividend reinvestment plans (DRIPs) and a knowledgeable authority on the operations of these plans. She provides financial information centered around DRIP investing at www.drp.com and www.directinvesting.com. She is the Editor and Publisher of Moneypaper's Guide to Direct Investment Plans, Chairman of the Board of Temper of the Times Investor Service, Inc. (a DRIP enrollment service), and co-manager of the MP 63 Fund (DRIPX).

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About the Author

Vita Nelson

Founding Publisher and Editor, Moneypaper

Ms. Vita Nelson is is the Editor and Publisher of Moneypaper's Guide to Direct Investment Plans, Chairman of the Board of Temper of the Times Investor Service, Inc. (a DRIP enrollment service), and co-manager of the MP 63 Fund (DRIPX).
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