Dear Dagen: NAV Is Not a Variable You Need to Worry About

Don't get hung up on a fund's net asset value.
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I recently left my employer to become self-employed and am looking to place my 401(k) into a fund such as (VFINX) - Get Report Vanguard 500 Index. However, I am hesitant to buy in at a net asset value of $128 or thereabouts. One question is whether or not to dump all my money immediately into a fund (and risk a market downturn) or to use dollar-cost averaging? -- Alvin Kernan

Alvin,

People quote me their net asset values all the time -- family, friends, even cab drivers. I'll often hear, "My fund is trading at 55, up from 45."

That tells me almost nothing. And when you're looking to buy a fund, its NAV will tell you about as much.

A fund's net asset value, or the dollar value of a single share, is based on the value of all the fund's holdings (minus liabilities) divided by the number of shares outstanding.

I think I understand your concern about the Vanguard fund. Often a new fund will launch with an NAV of 10. So the Vanguard 500 Index's NAV seems high.

But "it's not any kind of indication, along the lines of a valuation measure, of stock-market loftiness," says Jack Brod, principal in charge of asset management and trust services at

Vanguard

. "Decisions to invest should not be based on what the current NAV is."

And you don't really buy funds based on a number of shares, unlike stocks. You make purchases according to the dollar amount you have to invest.

If you want to know how a fund has done over time, you look at its total returns for various time periods expressed as percentages, which will let you compare the performance of one fund to another. When buying a fund, you can examine its past performance to get a sense of its track record, trading activity, turnover and volatility.

However, the NAV might actually give you some insight into a fund's tax efficiency. At least once a year, a fund will likely distribute its realized capital gains and dividends to shareholders, which will reduce the fund's NAV. Over time, growth or appreciation in the NAV "could be a sign that there have been less in the way of taxable distributions along the way and therefore more tax-efficient returns," says Brod.

Your NAV at purchase also comes into play when you want to sell a fund, as it's used to calculate your cost basis.

Using a Payment Plan

I haven't had any cab drivers ask about dollar-cost averaging, but it's still a big part of the conventional wisdom about mutual fund buying.

Dollar-cost averaging, or DCA for short, is an investment strategy in which a fixed-dollar amount is invested at regular intervals in a mutual fund, stock or other investment. According to proponents, this approach gets you to buy more shares when the price is low and fewer shares when the price is high. The result: Your average cost per share is always lower than the average price per share.

Often, you might see the idea of dollar-cost averaging lumped in with a fund family's automated investment plan that periodically deducts money from your checking account or paycheck and invests it directly into mutual funds. I am all for making periodic investments -- not necessarily because of DCA, but as a pure, solid savings mechanism.

Your situation is a little different. You have to decide whether to dump all your money into the market right now or dollar-cost average the money into the market over the next year or so in smaller increments.

In this scenario, dollar-cost averaging is what Vanguard's Brod refers to as an equity implementation plan. By putting your money into the equity market piecemeal, you eventually wind up fully invested, but you avoid having all your money at risk to a sudden near-term loss. In this case, DCA functions as a risk-reduction strategy. You are replacing one big risk with many smaller risks.

Here's an example. You are going to invest $3,000 in the stock of your favorite online retailer in three $1,000 installments over three months -- on the first of every month. The stock is trading at 32 today. Next month, it's at 25 a share. And the following month, it's down to 20 a share. The average stock price is $25.67, while your average cost is $24.74.

But obviously if the market rises, you would have been better off investing all of that money up front. DCA works best in a falling market.

By using dollar-cost averaging, an investor is essentially making a bearish bet that the investment or the market will go down, says Moshe Arye Milevsky, a finance professor at

York University

in Toronto. "It's the delaying of the decision that is the problem," he says. "It is simply a form of market-timing, and market-timing doesn't work."

Still, Milevsky suggests that if you are really concerned about volatility, you can invest one-half your lump sum immediately and put the other half in cash (like a money-market fund). Then at the end of a year, re-evaluate your decision.

Vanguard uses a much different rule of thumb.

If you are keeping your existing asset allocation the same, then you just put your money to work immediately.

However, if you are increasing your equity allocation by more than 10 percentage points, Vanguard suggests putting that money to work over one year in four or five installments.

Brod points out that studies do suggest two-thirds of the time, an upfront, lump sum investment would have done better than piecemeal investments because of the general performance of the stock market. Vanguard's approach is "really a psychological technique," Brod admits.

Either one of these approaches might help you sleep a bit more soundly if you are truly worried about a market blowup.

Send your questions and comments, along with your full name, to

deardagen@thestreet.com.

Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.