The suitability of a fund, unit investment trust (UIT), or real estate investment trust (REIT) is closely tied to the individual securities held in its portfolio. For example, the suitability of a large-cap stock fund is generally similar to the suitability of a large-cap stock. The main differences between funds/UITs and the individual securities they hold are diversification and fees.
Funds, UITs, and REITs can provide instant diversification. It’s common for a mutual fund to hold dozens - or even hundreds - of different securities. Rather than researching and selecting individual investments, an investor can buy a fund or UIT and have a professional manage the portfolio. This can be especially useful for retail investors who don’t have the time or expertise to research and monitor individual securities.
Diversification and professional management come with costs. These products may charge an expense ratio, sales charges, 12b-1 fees, management fees, and other expenses. Even when the benefits outweigh the fees, you still need to consider these costs when evaluating whether the investment is appropriate.
Dollar cost averaging is a common investment strategy used with investment companies, especially mutual funds. It involves investing a fixed dollar amount at regular intervals over time. This approach helps reduce market timing risk, which is the risk of investing a large amount right before a market decline.
For example, if an investor made a $100,000 investment right before the Great Recession of 2008 (such as in the summer of 2007), it would’ve taken over 4 years to recoup the losses from the downturn. The larger the one-time investment, the more exposed the investor is to a sharp decline soon after investing.
Now compare that to investing $1,000 per week over 100 weeks (roughly 2 years). When prices fall, the same $1,000 buys more shares. That’s the key mechanism behind dollar cost averaging: it spreads purchases across different price levels and tends to lower the investor’s average cost per share in a fluctuating market.
Let’s demonstrate with an example. Assume the following purchases of ABC mutual fund occur during a market decline:
| Date | Purchase amount | Price per share | Shares purchased |
|---|---|---|---|
| Jan 1 | $1,000 | $20 | 50 |
| Feb 1 | $1,000 | $16 | 62.5 |
| Mar 1 | $1,000 | $10 | 100 |
| Apr 1 | $1,000 | $8 | 125 |
Overall, the investor purchased $4,000 of ABC mutual fund over a four-month period. During that time, they purchased 337.5 shares. Now compare the average cost per share to the average price per share.
Average cost =
Average cost =
Average cost = $11.85
Now, the average price:
Average price =
Average price =
Average price =
Average price = $13.50
The average cost reflects both the prices paid and the number of shares purchased at each price. The average price is just the simple average of the prices at the time of each investment. In a fluctuating market, the average cost will be lower because the fixed investment amount buys more shares when prices are lower. Even in a bear market, continuing to invest can reduce the investor’s average cost per share.
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