Chapter 7 Review and Quiz

Chapter 7 Review and Quiz

Case 01 : Even at half price

Here, the starting price is $10. It went down to $2 over 7 years and jumped back up 3 years later to $5. The end price is half the value of the starting price. If you had invested only once at the beginning and waited 10 years, you would have lost half your money. Now what would have happened if you had invested every month? $100 per month makes $1,200 over a year, and 10 years later you get $12,000, right? What if you invest the same amount every single month in this fund with its price movements over the investment period, what would have happened to your $12,000? 

1. $7,200 2. $9,000 or 3. $13,900 

What do you think?
The correct answer is 3!

Even if the fund value decreases by half, you still make a profit. That's DCA investing! If you had put the same $12,000 in the fund all at once at the beginning and waited 10 years, you would have ended up with $6,000. But you're in the black with DCA investing...do you know why?

Case 02 : Even after dipping to 10 cent

It's an extreme case. Although you won't find such a case in your actual life, think of it as part of your training to understand the investment. The starting price was $10 and 7 years later, the price plummeted to 10. Then 3 years later at the 10-year mark of the investment period, the price recovered to $1.20, an 88% decrease in value from start to finish. If you had invested $100 monthly in this fund with such price fluctuations, what would have happened to your total $12,000 investment? 

1. $5,300
2. $9,800
3. $14,500 

What do you think?
The answer is 3!

Even after losing as much as 88%, the fund provided a profit of over 20%. Let's compare that with the previous case. It's surprising that this one makes us more money than the previous one.

Case 03 : When is the recovery?

The investment started at $10 and fell to $2 at the 5-year mark. With a steady, monthly DCA investment, you would suffer about a 60% loss at this low point. The fund goes back up to its original price of $10 over the remaining 5 years of the investment period and starts becoming profitable at some point during that time.

Between the 5-year and 10-year mark, when did the fund start making money for the investor?

1. After 6 years and 6 months
2. After 7 years and 10 months
3. After 8 years and 9 months 

Which one?
The answer is 1.

After 6 years and 6 months, or 18 months from the bottom, the fund became profitable. With DCA investing, if the price returns to a certain level after a decrease, you automatically make money. In a lump-sum investment, if the price does not return to its original level, there is no recovery in value. However, DCA investing is the quickest way to see a recovery. This is called the 'rapid recovery' effect of DCA investing.

Case 04 : Return to original Level

This is the same as the last example. The starting price is $10, It went down to $2 after 5 years and recovered back to the original price 5 years later at the 10-year mark. After 10 years, the price went back to its original level. In the case of a DCA investment of $100 a month with a total invested amount of $12,000, what would be the result?

1. $15,000
2. $19,600
3. $24,100 

What do you think?
The answer is 3!

The invested amount doubled thanks only to a recovery in price to its original level. This is the 'rebound' effect of DCA investing, which provides profit after falling prices just by having it go back to its starting point.

Case 05

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.

Case 06 : 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 

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.

Case 07 : When should I start (1)?

Consider a financial instrument with a price fluctuation as shown in the graph above. Although its movement over a period of only 10 years is represented, it continued to go up much the same way beyond that point. If a DCA investment over those 10 years was made and the numbers on the line represent start-up time options at 6-month intervals, at which point do you know you should have started to get the most out of your investment?

What do you think?
The answer is 2.

As a reference, the order from most to least lucrative start point is 2,3,1,4,5,6,7,8,9. You see that performance varies depending on the start-up timing. Changing the starting point would simultaneously change the amount of units you can purchase as well as the price. Ultimately, the value of the investment is decided by the result of amount x price, so both of these factors are essential.

Case 08: When should I start (2)?

This time, the start-up time options are spread out at 1-year intervals for each DCA investment of 10 years. Of the 9 points on the line, which one should you start from to get the most out of your investment?

What do you think?

The answer is 6.

Although the best time to start for the previous Case was the second highest point, in this Case the best starting point is almost at the bottom. As a reference, the order from most to least would be 6,5,4,7,3,8,2,9,1. A very random order indeed. Any forecasting would be very difficult based on such data. As you saw in the two previous cases, with DCA investing, starting at the lowest price doesn't necessarily provide favorable results and starting at a high price won't guarantee anything either. In the final analysis, results vary because the number of units of a fund we can purchase depends solely on how the price fluctuates after starting.

The best timing is only revealed retroactively. The time you start investing is but a single timing among multiple purchasing opportunities. So there's no point worrying about it. The best thing to do is starting early and buying as many units as possible. DCA investing provides the best results when starting as soon as possible.

Case 09 : Even if the goals is the same

The figure has two investment funds starting at $10 per unit and ending at $30 at the 10-year mark. Although their start and end prices are the same, their movements in between vary. Fund A zigzags up then down repeatedly on an upward slope, while Fund B zigzags down then up over and over also moving upward.

If DCA investing in both A and B, which one will provide the most profit? A or B?

What do you think?

The correct answer is B.

Although they both have identical start and end prices, their final end results differ incredibly. Fund A ended with $17,420, a 45% increase, while B finished at $23,744, up 98%! Why are these investment values so disparate even after starting and ending at exactly the same place? The reason is the amount purchased. Since the investment value is 'amount'price', even with the same ending price, the more units are in the coffer at the end, the higher the investment value. It's simple arithmetic!

Case 10 : If periods vary

Look at the three financial instruments A, B and C. They all started at $10 and ended at $100 only A did it in only 10 years, while B took 20 years and C spanned 30 years. If having DCA invested $100 per month in each of these products, which one ended with the highest investment This one is easy, right? Of course, C provides the most profit in the end because the longer you invest, the greater the amount of units you buy.

Actual results show that

Fund A ended at $31,157 ($12,000 invested; 925.6 units purchased),

Fund B at $61,855 ($24,000 invested; 618.6 units purchased)

Fund C at $92,555 ($36,000 invested; 311.6 units purchased).

This is a simple but extremely important point. The key to getting great results out of DCA investing is to never quit. I'll explain more about this later but you won't get such fantastic results just with a high price. It's important to stay in for as long as possible always increasing the amount of units. This method of investment gives you good results as long as you stick to it.

Case 11 : Slow increases

The above shows two funds A and B that both start at $10 and grow to $100. Fund A jumps sharply to $100 in 3 years then levels off, while B is flat for the first 7 years then shoots up during the last 3. If DCA investing $100 per month over the investment period, how will these funds perform? What is the correct combination of results? 

1. A: $42,445 B: $51,276
2. A: $35,614 B: $61,852
3. A: $22,009 B: $78,208
4. A: $18,081 B: $93,681 

What do you think?

The correct answer is 4.

With DCA investing, remember that the final price is important, but the price movements throughout the investment period which determines the number of units you ultimately buy is also important. In this case, even though they both reach the same point in the end, it's better to increase slowly towards that high final price in order to purchase as many units as possible and ensure a fantastic profit.

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