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Many investors were scared off by the market collapse of 2008-2009. North American and international equity markets fell hard offering investors a roller coaster ride - the scary part - when you get to the top and then head into free fall. Too many investors got off of that roller coaster and headed for the exits.

For starters, of course we should acknowledge their mistake. As Warren Buffett would point out, if you can't handle a 50% drop in stock prices, you should not be invested in stocks. Period. Find another way to invest.

Of course the risk averse investor can still invest in equities by combining those stocks with bonds and lowering the risk or volatility of the overall portfolio. From 2007, if an investor held a portfolio of equal parts (NYSEARCA:DIA) (the Dow Jones Industrial Average ETF) and (NYSEARCA:TLT) (iShares' 20-year Treasuries ETF) they would never have had to watch their portfolio go under water, whereas the pure U.S. equity portfolio went underwater by some 40% from its starting point, and it dropped some 60% or more from its peak. What's more, that simple balanced portfolio would still be in the lead today.

Portfolio = DIA / TLT

That simple 50-50 portfolio mix is not very diversified, though one could argue that simple mix would do the trick over the decades. As I pointed out in this article, "Streetwise Portfolios: Beating the U.S. Market with Lower Volatility," if one held a portfolio that also offered international diversification, they could have increased their returns and lowered the volatility even further.

Here's a ten year chart combining DIA plus the Canadian Index (NYSEARCA:EWC), the EAFE index (NYSEARCA:EFA) (Europe, Australasia and the Far East), and the TLT in equal amounts. If a U.S. investor suffered from home bias and unsuitable risk - they paid the price.

Portfolio = DIA / EFA / EWC / TLT. 10-years to February 2013

Anyway, enough preaching about the wonders of diversification - we have some investors who want to get back into the market. And that market is at all-time highs.

So what about those investors who left the ride in 2009? Well, as we Streetwise Coaches always like to say - every day is a good day to invest. One of my co-workers (let's call him Jim, cause, well, that's his name) uses a wonderful analogy. When a client is faced with the situation of being out of the markets and asks if now is a good time to start investing, Jim will offer "when is it a good time to plant a tree?"

It is always a good time to plant that tree of course. And then one must take care of that tree, with water and fertilizer. And be sure to trim the tree so it grows nice and tall and straight.

No one knows where the markets are going from here, as I discovered in this article that examined market tops over the last 100 years. It's a coin toss. We could head higher. We could stall. We could fall. Take your pick, but be prepared for everything short term, knowing that over the long term you're going to plant a tree that will grow very tall. It just might take 5-6 years, or perhaps a decade to reach for the sky.

Here's an interesting tidbit.

Over any 5-year time frame there is a 96% probability that an equity index will deliver positive gains.

Over a 10-year period there is a 100% probability that your stocks will be in positive territory. Here's an incredible interactive chart that shows the returns of asset classes, along with a balanced portfolio, plus inflation and interest rates charted from 1935.

The above page demonstrates that, if history holds true, the only risk is selling - cutting down that tree before you gave it a chance to grow. With that in mind, an investor who has been out of the equity markets might want to consider establishing a modest position and then averaging in over a two year time period. If the markets continue to go up, the investor will be content with their portfolio rising in value. If markets go down, or find a bumpy road, the investor can take some comfort in knowing that they are buying shares or units on sale, and hence are acquiring more shares or units than had the markets continued on an upward trajectory. The dollar cost averaging with also temper the volatility within the portfolio.

Here's a simple example of an averaging in scenario. Two investors have $30,000 invest. One investor goes "all in". The second investor decides to invest $10,000 and then "averages in" reinvesting the remaining $20,000 at regular intervals in equal amounts of $2,500.

Averaging inPortfolio Value20132013201420142015201520162016
$10,000$10,00011,50213,36214,28715,83420,59224,37834,04542,731
Reinvest 2,5002,5002,5002,5002,5002,5002,5002,500
Unit Price10.009.008.507.507.008.008.511.0013.00
Units Purch1,000278.00294.00333.00357.00312.00294.00227.00192.00
Total Units1,0001,2781,5721,9052,2622,5742,8683,0953,287
$ invested 12,50015,00017,50020,00022,50025,00027,50030,000
Returns -8%-11%-19%-21%-9%-3%24%42%
All in
$30,000$30,00027,00025,50022,50021,00024,00025,50033,00039,000
Returns -10%-15%-25%-30%-20%-15%10%30%

We can see that the investor who averaged in experienced much lower volatility and in the end created gains that were 29% greater than the "all in" investor. The investor who averaged in was able to buy units or shares "on sale". Of course in a rising market we would see the reverse. The all in investor would have seen greater gains - while the investor who averaged in would have left some gains on the table.

Here's a real life example. Let's pick the worst start date in 2008 - May. If an investor held the 50-50% balance of DIA and TLT from that date, they would now have a total return of 38%, and 6.8% annualized returns.

Portfolio = DIA / TLT (2008- Present)

Even the all-equity S&P 500 delivered a 25% total return from that May 2008 start date. Thanks again to low-risk-investing.com for the portfolio chart creation tools.

Conclusions

It's always a good day to invest. The only day better was yesterday. But first, an investor needs two things; time and patience.

If you don't have the stomach for roller coasters, average in and include bonds to lower the portfolio volatility.

There's money to be made. There's always money to be made by the patient investor. It's Spring, time to plant.

Source: Averaging In To A Market Top