Investment Strategies: Dollar Cost Averaging (DCA)

Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The investor purchases more shares when prices are low and fewer shares when prices are high. DCA reduces the impact of volatility on large purchases of financial assets such as equities. By dividing the total sum to be invested in the market (e.g. $100,000) into equal amounts put into the market at regular intervals (e.g. $1000 over 100 weeks), DCA reduces the risk of incurring a substantial loss resulting from investing the entire "lump sum" just before a fall in the market. Dollar cost averaging is not always the most profitable way to invest a large sum, but it minimizes downside risk.


In essence, the technique works in markets undergoing temporary declines because it exposes only part of the total sum to the decline. The technique is so-called because of its potential for reducing the average cost of shares bought. As the amount of shares that can be bought for a fixed amount of money varies inversely with their price, DCA effectively leads to more shares being purchased when their price is low and fewer when they are expensive. As a result, DCA can lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time.

Here are two different examples of dollar-cost-averaging that will help you understand it better:

 

 

Here are three different web links, if you want some deeper details on - what is dollar cost averaging, why dollar cost averaging is a smart strategy and why dollar cost averaging works well with mutual funds.

Difference between Asset Allocation and Diversification

Asset Allocation refers to investing in different categories of investments, called asset classes. That is, we pick which assets we want to have in our portfolio. Generally, investors choose from stocks (equities), bonds (fixed income), cash, commodities and real estate.

Diversification, on the other hand, is the process of balancing these classes – and within these classes – so they offset one another amid ever-changing market conditions.

(Source: Stockcharts.com)

Your asset allocation may represent a diversified portfolio or a concentrated portfolio, if you are only using a couple of specific asset classes, then it is probably a concentrated portfolio. The goal of portfolio diversification is to generate the highest possible return for a given level of risk. A portfolio of all small company stocks may result in greater returns than a diversified portfolio of stocks, but it is unlikely to achieve that result without significantly more risk or volatility.

Asset allocation is a key element of diversification. No asset class is the top performer each year, so selecting asset classes that are not well correlated or do not move in the same direction, makes sense.

Here is an example of a portfolio with asset allocation and diversification:

You may also want to read this article on stockcharts.com for a better understanding of the difference between Asset Allocation and Diversification.

Here is another detailed article- Beginners' Guide to Asset Allocation, Diversification, and Rebalancing I found on SEC's website.

Investment Strategies: Diversification

Diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets.

The goal of diversification is not necessarily to boost performance—it won’t ensure gains or guarantee against losses. But once you choose to target a level of risk based on your goals, time horizon, and tolerance for volatility, diversification may provide the potential to improve returns for that level of risk.

To build a diversified portfolio, you should look for assets—stocks, bonds, cash, or others—whose returns haven’t historically moved in the same direction, and to the same degree, and, ideally, assets whose returns typically move in opposite directions. This way, even if a portion of your portfolio is declining, the rest of your portfolio, hopefully, is growing. Thus, you can potentially offset some of the impact of a poorly performing asset class on your overall portfolio.

Within your individual stock holdings, beware of over-concentration in a single stock. For example, you may not want one stock to make up more than 5% of your stock portfolio. It would be smart to diversify across stocks by market capitalization (small, mid, and large caps), sectors, and geography.

Investment Strategies: Asset Allocation

Asset Allocation

Asset allocation is about not putting all your eggs in one basket. It's the ultimate protection should things go wrong in one investment class or sector, as is likely to be the case from time to time.

Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investment time frame. Asset allocation is based on the principle that different assets perform differently in different market and economic conditions. Asset allocation is both the process of dividing an investment portfolio among different asset categories, as the resulting division over stocks, bonds, and cash. This process of determining which mix of assets to hold in a portfolio is a personal one. The asset allocation that works best at any given stage in an investor's life will depend largely on the need, ability and willingness of the investor to take risk. These depend on the investment time horizon and on both the investor's financial capacity and emotional capacity to tolerate risk and to stay the course.

A key reason for devising an asset allocation strategy is to help reduce the risk inherent in volatile equity asset classes that are expected to provide higher returns by combining these asset classes with more stable fixed-income assets. These balanced portfolios help reduce volatility and down-side risk, thus better enabling an investor to maintain investments over a long term period.

There is a nice article I found on the the website of American Association of Individual Investors about asset allocation. You MUST read this article to get some more detailed understanding on asset allocation. Click on this link to read this article.

You can also use this Asset Allocation Calculator on Bankrate.com website to determine how you should diversify your portfolio to allocate your assets.

Factors to consider before investing

Before you invest your hard earned money in a particular investment vehicle, it is of paramount significance for you to know:

• What do your finances look like right now
• What is the goal of your investment- short term income, medium term growth or long term wealth
• What is the investment time frame you are looking at- short term, medium term or long term
• Know more details of your Investment Vehicle- Do not invest in anything you do not understand
• Minimum and Maximum amount limits of your investment
• If your Investment is portable to other vehicles without any penalty
• What is the ROI as compare to other investment vehicles
• How liquid your investment is in that particular account
• What is the level of risk involved
• Tax implications on your investments and returns
• Is it the only good investment option for you

 The mistake of making a wrong choice can not only offset the profits of your investment but also defeats the whole purpose of investing. Do your due diligence before investing and always remember past results of any investment do not guarantee its future performance.

Here is a link from SEC to learn about the 10 things to consider before you make investing decision.

Adjusted Gross Income (AGI) is the key word

While preparing your tax return, you probably spend more time on your "taxable income" without paying any attention whatsoever on your adjusted gross income (AGI). However, your Adjusted Gross Income (AGI) directly impacts the deductions and credits you’re eligible for—which can wind up reducing the amount of taxable income you report on the return.

Adjusted gross income (AGI) is an individual's total gross income minus specific deductions. Taxable income is adjusted gross income minus allowances for personal exemptions and itemized deductions. For most individual tax purposes, AGI is more relevant than gross income.

Your AGI is equal to the total income you report that’s subject to income tax such as earnings from your job, self-employment, alimony income and interest from a bank account minus specific deductions, or “adjustments” that you’re eligible to take. Your AGI is calculated before you take exemptions and the standard or itemized deduction—which you report in later sections of the return.

You can find AGI in the forms 1040, 1040A, 1040EZ or 1040NR.

Click here for more information on AGI and click here to learn more about the AGI implications on taxes.

Tax Brackets and Social Security Benefits

Worried About Your Retirement? Well! You should be. Specially if you are fourty something and still have no clear plans for your retirement. Social security benefits alone are not going to be helpful at all. The maximum social security benefit depends on the age you retire. For example, if you retire at full retirement age in 2016, your maximum benefit would be $2,639. However, if you retire at age 62 in 2016, your maximum benefit would be $2,102. If you retire at age 70 in 2016, your maximum benefit would be $3,576.

Merely putting money in your saving accounts does not help either. The interest rate on you money in saving accounts probably does not even beat the rate of inflation. an that's why you MUST invest your money in some place where it can grow itself at a rate where the residual amount should be decent enough for your retirement, even after paying taxes and beating the inflation.

Every year, the IRS adjusts more than 40 tax provisions for inflation. This is done to prevent what is called “bracket creep.” This is the phenomenon by which people are pushed into higher income tax brackets or have reduced value from credits or deductions due to inflation, instead of any increase in real income. IRS uses the Consumer Price Index (CPI) to calculate the past year’s inflation and adjusts income thresholds, deduction amounts, and credit values accordingly. Rather than directly adjusting last year’s values for annual inflation, each provision is adjusted from a specified base year.

Click here for more information on tax brackets.