There are several reasons to wade back into the market this week – the Dow is down 20% for the year, the S&P 500 fell 8% on Monday, and Warren Buffet is buying.  Although there is blood on Wall Street, there is not yet blood on every street- especially Main Street.  In short, I think the economy will get worse before it gets better, but it’s time to start buying.

Most financial advisors recommend ‘dollar cost averaging’ as a buying strategy.  I also think this strategy is very wise for the next six months.  Specifically, I would recommend buying equal amounts three times: next week, the week around Christmas, and one week in November or February. 

For the reasons stated above, now would be a good time to put money into the market. The market has taken such a beating recently that it is unlikely you will be ‘buying high’.  Additionally, valuation ratios have also improved- the P/E ratio for the S&P 500 is 13.3 with a 2.8% dividend yield- and the bailout bill will probably give the market some sort of temporary boost.  The market will not run away quickly, but buying now would create a great baseline for investments with a long time horizon.

The week around December 25th should be another time to invest money for two reasons. First, many institutional investors and individuals sell in the last part of December to realize tax losses for the year. Since the market has dropped so precipitously, there will most likely be a lot of selling this year.  Second, the economy will most likely continue to suffer, pushing stock prices down even further. 

The market is just starting to price in declining home sales, higher unemployment, and weaker consumer spending. These factors will most likely worsen due to the ‘credit crunch’ of the past two weeks. (Note: Trading volume around the holidays is usually light. Thus prices can be artificially high during this time.)

Finally, I would recommend making the final purchase in November or February to spread your money over an equal time horizon.  I view this purchase as a ‘real option’ to the state of the economy. If you feel the economy will get worse next year, buy in February. If you feel it will start to improve by February, buy in November.  Just remember, that the market tends to anticipate economic recoveries by about six months.

Another factor you might want to consider before timing this purchase is the January Effect. The January Effect favors a purchase in November, since stocks tend to rally in January due to New Year’s optimism and the rebalancing of portfolios.  Although it is impossible to time the market, the important thing to remember is to make this purchase at a regular interval with the other two purchases. This will increase the odds that your average price will be lower.

Finally, I always like to buy on a down day. Although I know the chances of the market going up on any given day is 50%, it makes me feel better to buy when everyone else is selling. If the market climbs the following day, even better. 

In full disclosure, I will be following the strategy I just outlined. For the past couple months, I have been sitting with 40% of my portfolio in cash, and yesterday I committed a third of that money to the market.  With so much fear and uncertainty in the market, I feel it is a great time to get back in. However, I want my head above water in case we’re hit with a wave of selling. After all, no one likes getting salt water in their mouth!

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