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By: Costas Bocelli — October 10, 2013

The Advice I'm About to Give Isn't Fancy, But...

With President Obama’s formal nomination of Janet Yellen to become the next Chairperson to lead the Federal Reserve, current Fed Chief Ben Bernanke can now officially be labeled a “lame duck”.

But don’t let that description fool you, because Bernanke’s approach to monetary policy ever since the credit crisis erupted in 2008 has been anything but lame.

Under his watch, the Fed’s balance sheet has ballooned from $800 billion to now over $3.7 trillion as a bond buying binge (quantitative easing) has been the weapon of choice to fight recession, high unemployment, subpar economic growth and bouts of disinflation.

It’s indeed been a bold action led by the outgoing Fed Chairman, and now the reins will be handed over to the current Vice-Chair Yellen.

And if you think that the bull market rally since the 2009 lows has a lot to do with the massive stimulus injections the Fed has been pumping into the financial systems, then you should be pleased to know that future monetary policy will be left in good hands.

Vice-Chair Yellen has been a leading voice for keeping policy ultra-accommodative, and it should be a smooth and comfortable transition.

She’ll also make sure to photocopy Bernanke’s playbook before his term expires at the end of January.

And with years of experience as a member of the Federal Reserve and serving directly as Bernanke’s number two, she’s likely more than capable of drawing up a few creative plays of her own if the economy takes another turn for the worse.

The FOMC last met on monetary policy in the middle of September, and the committee surprised the markets by opting not to reduce the size of their monthly asset purchases.

The decision actually turned out to be a close call, and the members engaged in a lively debate.  The minutes to that meeting were just released yesterday afternoon and revealed how divided the committee had become on the tapering issue.

There’s also little doubt that the dovish argument to keep the size of the stimulus purchases unchanged were led by Bernanke and Yellen.

And based on the charade we’re witnessing over the impasse in the fiscal and debt ceiling debates, they’ve been proven right to maintain support at current levels as the government’s partial shutdown enters the tenth day and the prospect of the Treasury exhausting all of its funds to pay its bills is exactly one week away.

The Treasury department has announced that it will exhaust all its emergency measures to remain under the debt ceiling no later than October 17, leaving only roughly $30 billion cash on hand, which is akin to running on fumes.

But that date is somewhat arbitrary, as the net expenditures forecast between then and the end of the month is expected to be less than the projected cash balance.

So the market’s whisper date is actually November 1.

That’s a day that the Treasury is scheduled to pay out $67 billion in entitlements, military pay and Medicare.

So by month end... with still no deal to lift the debt ceiling... somebody’s going to get stiffed.

And because the fiscal fiasco continues to drag on, the major stock market averages have sunk to one-month lows and volatility (as measured by the VIX) has surged.

The CBOE volatility index hit an intraday high just over 21 in yesterday’s session, which is one of the highest readings of the year.  It did settle lower but still remains elevated near 20.

Institutional investors were also dumping short-term treasury bills that expired in the next several weeks in fear that a failure to raise the debt limit may prompt some type of technical default.

On Tuesday, which happened to be the sharpest sell-off for stocks since the August lows, we saw the Treasury having to pay 0.35% on a $30 billion offering.  That may not seem like a very high interest rate, but considering that 4-week loans were costing Uncle Sam less than 0.10% just a couple of weeks ago, it’s very telling that the markets are getting more and more anxious as a deal out of Washington remains elusive.

What to do, what to do?

If you’re a newbie just getting starting, or a typical buy and hold investor who’s been waiting for one of those pullbacks so you can “buy the dip”, well here’s your opportunity.

The investment advice I’m going to share is not fancy, but can be very effective.

It’s actually quite simple and suitable for buying into markets when there is a lot of fear and uncertainty swirling around.

The strategy is a 3-step approach and attempts to dollar cost average your investment and smooth out all the volatility that would otherwise scare many investors from taking advantage of market pullbacks like we’re experiencing now.

I’ll use a friend of mine’s situation as an example, because it’s very common among the typical average person that simply wants to invest a portion of his (or her) money in the stock market.

My friend has about $10,000 set aside in a money market account that’s earning close to zero interest.  He’s been waiting for a pullback to invest, but now is scared that if he sticks it in, the market may plunge as it did during the last debt ceiling negotiations in the summer of 2011.

So my advice was simple:

Slice your purchases into three pieces.  Find specific levels and buy in thirds in ETFs or individual stocks that you’re interested in.

With the markets now at one-month lows, the first purchase looks pretty good right here.

I told him to look at the Dow Jones Industrial Average.  It’s sold off 900 points -- about 6% -- from its peak.  The index also is nearing a key support level and the 200-day moving average.  So if you’ve been on the sidelines, this looks like a good entry point for a portion of your total investment.

Invest one-third right now, leave two-thirds in cash...

Then, I told him to watch the S&P 500 index.  The index has pulled back about 4% from its peak, but if it should happen to decline further from here, look to invest another third somewhere in the highlighted range around 1630 to 1600.  That also comes into another area of broad based market support as measured by this large-cap index.

Invest another third if the S&P 500 falls another 2 to 3 percent...

That leaves us two-thirds invested in equities and one-third in cash.

What about the final piece?

The last third is for an event very similar to what markets experienced in the summer of 2011 when lawmakers took the country to the brink of default and prompted Standard and Poor's to slash the US AAA credit rating.

The peak to trough decline was in the 20% neighborhood, but after the dust settled it turned out to be one of those memorable buying opportunities for investors that took advantage of all the panic selling.

You’ll know when the third piece should be bought, because it will be the most nervous purchase of the three.  The key signal is when you see investors capitulate on very heavy volume that’s soon followed by an abrupt bullish reversal; that’s your third piece!

The reality is that investing is never easy to begin with, and can be downright scary during uncertain times like these.

But any opportunities that offer stocks at discounted prices always come with elevated fear -- that’s what makes them compelling bargains.

And using a piece meal dollar-cost averaging approach can take a lot of guess work and anxiety out of the decision making by mapping out a simple investing game plan like we’ve done today.

Happy Investing!

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