Regular investment . . . it works

Posted on 23rd February 2010 by Trevor Reynolds in Blog

The World Markets are volatile but if you are a regular investor with a reasonable time horizon this is an incredible opportunity. Why you ask? Because of the power of monthly investing.

There are a couple of reasons why you would want to invest in your on a monthly basis rather than wait until the end of the year or to try time it (no one can correctly with any real consistency). The first reason is obvious to everyone, a little bit invested is usually not even seen on a monthly basis, just another bill on the credit card!  If one invested once a year it is either avoided or thought of as a gee I would rather have a . . .  and it is spent not saved. (We see this a lot!)

There is a good investment reason why you would want to invest on a monthly basis that isn’t so obvious. In the industry, investing on a regular basis is called “dollar cost averaging”. I don’t know who invented that term, or if they meant for it to be descriptive, but it doesn’t really describe anything to me. “Investing regularly” is more descriptive to me.

I am going to look at three scenarios, in each scenario we invest $100 monthly:

  1. one where the investment goes up steadily, month after month, starting at $10.00 per unit and ending up at $12.75;
  2. one where the investment goes up, and down, up and down, starting at $10.00 per unit and ending at $12.75; and lastly
  3. a horrible investment that starts at $10.00, goes steadily down until it hits a bottom of $5.00, then slowly works its way back up to $10.00, the original price.

Which is the best investment? Intuitively the first one is the best, followed by the second, followed by the third. If that’s what you picked, you would be right if you had a lump sum to invest, but completely wrong if you were investing regularly.

Let’s look at the numbers.

Example a) Investment goes straight up;

Month Monthly Investment Unit Price Units Purchased
January $100 $10.00 10.0000
February $100 $10.25 9.7561
March $100 $10.50 9.5238
April $100 $10.75 9.3023
May $100 $11.00 9.0909
June $100 $11.25 8.8889
July $100 $11.50 8.6957
August $100 $11.75 8.5106
September $100 $12.00 8.3333
October $100 $12.25 8.1633
November $100 $12.50 8.0000
December $100 $12.75 7.8431
Total $1,200 106.1081

Market Price = Total Units x Most Recent Price = $12.75 times 106.1081 = $1,352.88

Profit = Market Price – Cost = $1,352.88 – $1,200 = $152.88

Example b) Investment goes up and down, up and down, much like the market does in reality;

Month Monthly Investment Unit Price Units Purchased
January $100 $10.00 10.0000
February $100 $9.75 10.2564
March $100 $9.50 10.5263
April $100 $9.25 10.8108
May $100 $10.00 10.0000
June $100 $10.25 9.7561
July $100 $10.50 9.5238
August $100 $9.75 10.2564
September $100 $11.00 9.0909
October $100 $11.50 8.6957
November $100 $12.50 8.0000
December $100 $12.75 7.8431
Total $1,200 114.7596

Market Price = Total Units x Most Recent Price = $12.75 times 114.7596 = $1,463.18

Profit = Market Price – Cost = $1,463.18 – $1,200 = $263.18

Example c) investment starts at $10 drops to $5 then goes back up to $10, like when the market crashes.

Month Monthly Investment Unit Price Units Purchased
January $100 $10.00 10.0000
February $100 $9.00 11.1111
March $100 $8.00 12.5000
April $100 $7.00 14.2857
May $100 $6.00 16.6667
June $100 $5.00 20.0000
July $100 $5.00 20.0000
August $100 $6.00 16.6667
September $100 $7.00 14.2857
October $100 $8.00 12.5000
November $100 $9.00 11.1111
December $100 $10.00 10.0000
Total $1,200 169.1270

Market Price = Total Units x Most Recent Price $1,691.27

Market Price = Total Units x Most Recent Price = $10.00 times 169.1270 = $1,691.27

Profit = Market Price – Cost = $1,691.27 – $1,200 = $491.27

The dollar cost averaging profits.

Scenario 1 Scenario 2 Scenario 3
$152.88 $263.18 $491.27

The investment that looked to be the worst was actually the best. Wouldn’t you agree that dollar cost averaging, or, simply investing regularly is a pretty good way to invest?

A monthly savings with Royal Skandia –  Why?  Cost averaging and the fact Royal Skandia has re-launched their special offer for 2009 and their plan is the cheapest monthly savings product on the market – the cost to get into the funds is only 0.49%.  Skandia has a 1% management charge and an $8.50 monthly administration fee, that’s it.  What I am suggesting here is, if you want to save for 10 years – this is the best plan – providing US$750+ a month is a comfortable level to save each month. The benefit of dollar cost averaging will be at work here and you can more aggressively invest in emerging markets. There are good companies in emerging markets available on the very cheap now, the economic deep freeze won’t last forever. If you build positions in Energy, Gold, Asian, Chinese, Indian, Latin American and Russian investments for a few years, you will be amply rewarded over time.

Get in touch with Banner today and get something started, as you will be happy you did. As Few people in their twenties, thirties or even in their forties give serious attention to their pension savings. Retirement may seem a long way off to you and other financial demands seem more pressing. But because of increasing longevity, earlier retirement and higher expectations in retirement, not to mention numerous state schemes moving “into difficulty” are all compounding reasons which increases the need to plan. Take the time to review your options, and ensure that you’re prepared when it’s your turn to retire.  And call Banner as we can help.