Monday, July 30, 2007

Dollar-Cost Averaging Principle

The Principle of Dollar-Cost Averaging involves a diciplined regular investment technique which may be applied to maximum effect in unit trust investing. This investing technique intended to reduce exposure to risk associated with making a lump sum purchase. All an investor has to do is to invest a regular fixed sum of money with a selected unit trust fund over a period of time (daily, weekly, monthly, quaterly, etc.). This way, investor does not have to worry about market timing, or where shares prices or interest rates are headed. Regular investment will purchase less units when market is up, and more units when market is down. It safeguards against the market losing value shortly after making investment and limit the downside of an immediate drop in asset value after a lump sum is invested.

Illustration:



Let us assume Investor A decided to invest a monthly savings of RM400 with the fund over a period of 24 months.

In the first 12 months, Investor A thus managed to accumulate 8,026.47 units at an average cost of RM0.5980 per unit at market uptrend whereas the average NAV per unit over the period was higher at RM0.6008.

During the next 12 months, Investor A manage to accumulate a total of 9,270.36 units at an average cost of RM0.5178 per unit at market downtrend which is lower than the average NAV per unit over the period at RM0.5183.

Units will be bought at an actual cost which is lower than the average NAV per unit over the same period by regular investing the same amount of money in the fund irrespective of price fluctuations.

Also referred to as constant dollar plan. In the United Kingdom, it is known as pound-cost averaging.

In Malaysia, it is known as ringgit malaysia-cost averaging. *quote by kkchow23

2 comments:

kkchow23 said...

Refering to comment at Irwan’s Blog :
http://www.irwan.biz/dramatization-dollar-cost-averaging/#comment-42432

Quote from norisa:
“So how could I calculate my profit since I have invested RM2,000 (during the launching period where I got 80 free units so total units 8080 units) then starting 8 june I start my S.I. every month RM500.”

Example 1
========

Public Islamic Asia Dividend Fund (PIADF)

——————————————–

At 03/04/07, NAV price is RM0.2347.

Amount Paid : RM 2,000.00
Sales Charge (6.49%): RM 122.40
Amount Invested : RM 1,877.60

Price (RM) : 0.2347
Units : 8,000
Total Cum Cost (RM) : 2,000.00
Avg Cost Per Unit (RM) : 0.2500

But because of promotional period (offer 1% free units):

Units : 8,000 + 1% = 8080
Total Cum Cost (RM) : 2,000.00
Avg Cost Per Unit (RM) : 2,000 / 8080 = 0.2475

At 08/06/07, NAV price is RM0.2397.

Units (07/06/07) : 8080
Additional Investment : RM500.00
Sales Charge (6.49%): RM 30.55
Amount Invested : RM 469.45

Price (RM) : 0.2397
Units : 1,958.48
Cost (RM) : 500.00
Avg Cost Per Unit (RM) : 0.2553

Balance units : 10,038.48
Total Cum Cost (RM) : 2,500.00
Avg Cost Per Unit (RM) : 0.2490

At 09/07/07, NAV price is RM0.2552.

Units (08/07/07) : 10,038.48
Additional Investment : RM500.00
Sales Charge (6.49%): RM 30.54
Amount Invested : RM 469.46

Price (RM) : 0.2552
Units : 1,839.59
Cost (RM) : 500.00
Avg Cost Per Unit (RM) : 0.2718

Balance units : 11,878.07
Total Cum Cost (RM) : 3,000.00
Avg Cost Per Unit (RM) : 0.2526

At 27/07/07, NAV price is RM0.2496.

Units : 11,878.07
Price (RM) : 0.2496
Amount Redeemed/Repurchase (RM) : 2,964.77
Profit = RM2,964.77 - RM3,000
= -RM35.23

Simple Estimate Return : -1.17%

kkchow23 said...

If you were to invest lump sum, the estimate return will be slightly more due to the market uptrend. But we must always consider this; Do we have that amount of money during that time? Do we know what will happen in the future? What if the market goes downtrend instead?

Your investment will be something similar to this:

Example 2
========

Public Islamic Asia Dividend Fund (PIADF)

——————————————–

At 03/04/07, NAV price is RM0.2347.

Amount Paid : RM 3,000.00
Sales Charge (6.49%): RM 183.60
Amount Invested : RM 2,816.40

Price (RM) : 0.2347
Units : 12,000
Total Cum Cost (RM) : 3,000.00
Avg Cost Per Unit (RM) : 0.2500

But because of promotional period (offer 1% free units):

Units : 12,000 + 1% = 12,120
Total Cum Cost (RM) : 2,000.00
Avg Cost Per Unit (RM) : 3,000 / 12,120 = 0.2475

At 27/07/07, NAV price is RM0.2496.

Units : 12,120
Price (RM) : 0.2496
Amount Redeemed/Repurchase (RM) : 3,025.15
Profit = RM3,025.15 - RM3,000
= RM25.15

Simple Estimate Return : 0.84%