Selwyn Gerber writes:

Accounting

It is important to have a plan for a gradual entry into the market, and an exit approach designed to meet your life needs while accepting the fact that markets can decline sharply and suddenly. The decision on when to buy or sell is different than whether to buy and sell. Understanding this distinction is important to successful investors.

"If I lay you on a bed with you head in a furnace and your feet in a freezer, on average you'll feel comfortable"
- Rip Van Winkle Wisdom

Tax planning

Dollar cost averaging is a well-known investment technique. It is usually thought of as investing a fixed amount into stocks or mutual funds every month. This idea protects you from using all of your investment capital to buy something at a top and watching your investment value plummet. It is a very effective strategy for reducing timing risk, since the price will be very likely to fluctuate and some of the purchases will be made at lower prices than the initial investment.

Accounting

This “get rich slowly” strategy is the basis of most retirement plans. Each month the employee contributes a small part of his salary to fund a brighter future. Over time, these small amounts grow to a sizable account. Most people make the strategic decision to invest a large portion of their retirement accounts into equities. Using a tax advantaged account, the tactical decision of when to buy is dictated largely by their employer and the tax laws. Buying a small amount on each payday avoids the decision of whether the market is high or low. Annual contribution limits also help investors to sidestep the timing decision. Timing the investment this way is one of the best things you can do to passively take advantage of the upward trend of the markets, while occasionally buying more during market declines.

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Diversification is another well-known investment technique, used to limit risk and portfolio volatility. Dollar cost averaging is a form of diversification over time, an idea that introduces yet another form of risk-reducing diversification to the portfolio. Instead of investing all of your assets as a single lump sum, you work into the position by slowly buying smaller amounts over a longer period of time. This spreads the cost basis out over several years, insulating you from the risk of a sharp downward change in market price.

To see the value of dollar cost averaging, let’s consider the case of a hypothetical investor suffering from irrational exuberance in April 2000 with $500,000 to invest. Investing the entire sum into an ETF that tracks the S&P 500, this investor would have lost nearly 20 percent of the investment five years later. Investing that $500,000 in equal parts over the next eight quarters would have resulted in a loss of only 7 percent, an amount that would have been almost completely offset by dividends.

A variant of this idea is dollar value averaging, which is a technique to increase the portfolio value by a set amount each period. While dollar cost averaging requires a fixed amount of money to be invested during each time period, dollar value averaging requires the portfolio value to grow by a set amount each time periods. Although it may be too complex for most investors, high net worth individuals may want to consider dollar value averaging as a way to meet long-term capital appreciation goals. To apply this strategy, when the market declines, you will need to add more to your account; but in bull markets, you contributes less and might even need to withdraw some funds in any given time period. It takes advantage of the idea of “buy low, sell high.”

Proponents of dollar value averaging point out that this method guarantees a rate of return on your investment. The downside to this strategy is that you may need to provide a large amount of cash should the market decline significantly. However, research has demonstrated that the method will result in higher returns with about the same amount of risk as dollar cost averaging, especially over long time horizons.

While dollar cost averaging is usually thought of as a way to enter the market, it is equally effective as an exit strategy. Given the long-term upward bias of the market, it only makes sense to sell a little at a time. Large investors frequently employ this strategy. Bill Gates sells an average of $20 million worth of Microsoft stock each month to diversify his holdings. One would think he would know exactly the best time to sell or hold shares in his company. However, he recognizes that stocks are different than companies and even he can’t predict the market’s reaction to events impacting Microsoft. He chooses to sell over time as a strategy to maximize his gains.

“Usually when clients ask whether he should sell a position or not, we counsel them to sell a portion. Very few decisions are all-or-nothing”
- Rip Van Winkle Wisdom

The actions of Bill Gates illustrate the fact that dollar cost averaging applies not only to index funds but to any significant investment holding. The bond ladder is an example of dollar cost averaging for fixed income investments. The reality is that buying and selling are typically not "all or nothing" decisions. Often a graduated and staged move in or out is far more conservative and helps to shield the average price paid (or received) from excessive volatility.

Dollar cost averaging, and perhaps value cost averaging, are important to keep in mind when deciding how to manage risk when investing and when liquidating investment positions. Having and executing a planned and gradual entry and exit approach ensures that you separate the strategic decision of asset allocation from the tactical, market timing decision which is impossible to consistently get right.

For those thinking that successful investment requires more advanced concepts, we conclude this section with thoughts from David F. Swensen, the money manager for the Yale endowment, which ended 2006 with a 28 percent profit on $22.5 billion in assets. He offered these thoughts to individual investors seeking to manage their own portfolios:

Forget about making fancy market moves and focus on long-term gains…and, definitely ignore the advice of CNBC…whose investing strategies come with heavy commissions and costly tax consequences.
Rather than trying to pick individual stocks or time the market, investors should "diversify against ignorance” by choosing to invest in index funds, exchange-traded funds and other low-cost instruments, and adhere firmly to a balanced, long-term asset allocation regardless of tumultuous markets.
For instance, consider portfolio allocations of 30 percent domestic stocks, 15 percent foreign stocks, and 5 percent emerging-market stocks plus 20 percent in real estate index funds and 15 percent each in Treasury bonds and Treasury inflation-protected securities, or TIPS.
"If the dollar declines dramatically, you have foreign and emerging-market equities,” he says. Even though a declining dollar may fuel inflation, a diversified portfolio would provide a hedge.
"When you are putting fresh money to work you put it in an asset class where you are underweight and take money out of a class that is overweight,” he says.
Swensen’s final words of advice: Let yourself "off the hook” by not becoming anxious when markets decline. Stick strictly to the long view.
“If you pursue the sensible long-term policy, look at it over a 5-to-10-year period. Don’t look at five months,” he advises.