Chapter 3
Chapter 3 ââÅ¡¬ÃƒÆ’…Low StressââÅ¡¬ Effect:
Automatic investment vs. Lump-sum investment
All my previous examples featured falling prices. This time, I'll show you one where the price goes up. You'll see how this has a bad effect on performance compared to a lump-sum investment.
The starting price is $10 and at the 10-year mark, it doubles to $20. If DCA investing $100 a month in this fund, total $12,000, what would be the outcome?
1. $10,800 2. $16,700 3. $19,600
Which one? The answer is 2. Although you made money, it was nowhere near the $24,000 you would have gotten if you placed the $12,000 in a lump-sum at the beginning of the investment period. In this case, DCA investing provides less profit than lump-sum investing. What's the reason? Let's use the same formula to analyze this case.
Investment Value = Amount x Price
When DCA investing in a fund whose price constantly goes up, the number of units you can purchase keeps going down throughout the investment period. As a result, you buy fewer units than you would if investing a lump-sum at the start. Such a one-time, lump-sum investment in a fund whose price only goes up thereafter means you buy in at the lowest point when the highest amount of units can be purchased. A DCA investment in such an ever-increasing product is not very effective compared to a lump-sum investment, but nevertheless, there is no loss. DCA investing can be thought of as a source of moderate gains.
Figure.XXXX : Going up, then dipping a little
Let's look at a case where the price falls a little after a steady rise. Started at $10, it went up to $18 by the 7-year mark, then dipped to $15 after 10 years, a 50% increase from the beginning. DCA investing $100 per month, $12,000 total, in this fund over 10 years would have provided how much of a return?
1. $10,200 2. $12,700 3. $14,800
What do you think? The answer is 2. Even when the fund increases by 50%, the DCA investor only gets a 5% profit, or $600. The reason can be understood, as you can guess, using the formula. In the end, the rising value results in a low amount of units purchased.
Figure.20 : Return to original price
Before concluding this Chapter, let's look at one more case. Starting at $10, the fund rose to $18 after 5 years and went back down to $10 at the end of the 10-year investment period. It went up, then back down to the original price. What would be the result of a DCA investment of $100 monthly totaling $12,000 over the 10 years?
1. $5,940 2. $8,820 3. $10,200
What do you think? The answer is 2, unfortunately the investor is in the red. This case of a DCA investment that goes up and down results in a sharp decline in value. Please keep this case in mind. You carefully invest your hard-earned money only to see it washed away in the end. It's very important to view this type of investment the right way. As I explained a little earlier, when prices fall, the amount you buy up is high. For this case, the very end of the investment period is the right time to buy lot of units. This pattern would certainly provide negative results, but if you decide to continue, who knows what might come of this investment. That's because when prices are falling, more units can be purchased. If ending at the 10-year mark, then there would have to be some upward movement when time is up, but if continuing the DCA investment beyond the 10 years, that point may have some merits.
Next: Chapter 4 ââÅ¡¬ÃƒÆ’…No timingââÅ¡¬ Effect
