A Safer Way for Small Investors to Buy Stocks

You think the stock market looks tempting: The Dow Jones industrial average is up 7.5% since Jan. 1 and volume has been picking up. But like most small investors these days, you hesitate to jump in for fear that equities may be peaking and are due for a big correction.

Fortunately, many stock mutual fund companies in recent years have made this process easier, and as a result it is gaining popularity among many investors.

Dollar cost averaging is, in effect, buying through an installment plan. Instead of investing in one lump sum, you invest in regular increments: say, $100 a month, instead of $1,000 all at once.

Such a process relieves you of trying to predict market peaks and valleys--something at which most investors, including professional money managers, fail miserably. If the market goes up, you will be thankful that you are earning profits while you continually invest more. If the market goes down, you will be happy because you will be buying shares at lower and lower prices, reducing your average costs. And you’ll feel a lot better than had you invested your whole bundle at a market peak.

One key to making dollar cost averaging work is being sure you don’t stop when the market tumbles.

“Dollar cost averaging is an excellent way to make any kind of investment, but the problem with it (is that) when things are going badly, investors stop,” says Kurt Brouwer, a San Francisco investment adviser who manages mutual fund portfolios. “After the (October, 1987) crash, people just stopped. But that is exactly when you should be doing it, because you will be buying at the cheapest point.”

Another advantage of dollar cost averaging: It is a good form of forced savings, making you set aside a certain amount of your earnings every month for long-term investing. Over time, you could build a considerable nest egg that you can use to buy a home, fund your childrens’ education or provide for a comfortable retirement.

And dollar cost averaging gets you to think of stocks as a long-term investment, which is appropriate anyway for small investors who don’t follow the market on a day-to-day basis like the pros. For while stocks definitely are more volatile than bonds or certificates of deposit, over the long run they consistently outperform other paper investments.

Dollar cost averaging can be applied to individual stocks, but it is best applied to mutual funds. That is because buying individual stocks in small amounts can be costly; brokerage firms typically charge higher commission rates on smaller purchases. But applying dollar cost averaging to no-load mutual funds won’t cost you anything extra, since those funds don’t charge sales commissions anyway. And small investors gain diversification and professional management through mutual funds.

Realizing the demand among investors for dollar cost averaging, many larger fund groups have set up programs in recent years to do it for you. Many investors say they don’t have the discipline to write a check every month on their own, says Stanley Egener, president of Neuberger & Berman, a New York mutual fund company.

Ask your fund group if it has such programs.

Some fund families, such as T. Rowe Price, will arrange with your employer to have a certain amount--as little as $50 a month--automatically taken from your paycheck at work. The money is then invested directly into the fund of your choice. Major employers doing this with T. Rowe Price include Hughes Aircraft, AT&T;, Unisys and Coldwell Banker, says T. Rowe Price spokesman Steve Norwitz.

Other fund families, including Fidelity and many others, can arrange to have a set amount transferred from your checking account at a bank or savings and loan into a mutual fund. These usually require minimum monthly withdrawals of at least $50 or $100, but most larger banks and S&Ls; will do it, usually without charge. T. Rowe Price also allows you to order discretionary transfers through a toll-free telephone number. In any case, you generally will need to first open an account in the fund you are transferring money into, meeting its initial minimum investment requirement.

Still other fund groups, such as Neuberger & Berman, will allow you to designate a set amount to be withdrawn each month from your money market mutual fund. That money is then reinvested into another fund in that group. Neuberger & Berman, for example, requires you to place $5,000 or more into any one of its money market funds and then designate how much you want transferred on a monthly basis, with a minimum of $100 a month.

And some fund groups, such as Fidelity and T. Rowe Price, will reinvest dividends or capital gains that your earn in one fund into another fund in that group. Fidelity, the nation’s largest mutual fund group, just started such a program, called Directed Dividends. It, like other programs, first requires you to open an account in the fund to which you are transferring funds.

These and other programs are provided free of charge by fund companies, although you will have to pay any loads (sales commissions) charged by the funds you are buying.

Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.