Thursday, 16 May 2013

Dollar Cost Averaging In Unit Trust! Is it Practicable?

In my previous post on Stocks or Unit Trust, I mentioned about consistent investing via unit trust using the Dollar Cost Averaging method. In this post, I intend to elaborate further about Dollar Cost Averaging and it's effectiveness in unit trust investment. 

What is Dollar Cost Averaging?
According to Investopedia, Dollar Cost Averaging is defined as;

"The technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high."

From the perspective of unit trust, the method for Dollar Cost Averaging is the act of consistently  purchasing of units (normally on a monthly or quarterly basis) at a fixed amount regardless of the price of the unit trust. When using the Dollar Cost Averaging method, unit trust investors need not be bother with the economic situation or how the stock market is performing. The objective is to consistently purchase units at whatever the price of the unit trust.

Here's a sample table illustrating how the Dollar Cost Averaging method is applied;

Month
Unit Trust Price
Amount Invested
Units Accumulated
Jan-13
RM 0.50
RM1000
2000
Feb-13
RM 0.40
RM1000
2500
Mar-13
RM 0.80
RM1000
1250
Total Units Accumulated
5750

After investing RM1000 consistently for 3 months (Jan 2013 - March 2013), the investor has accumulated 5750 worth of units. The average per unit price of the investor is calculated as follows:

Total Amount Invested : RM3000
Accumulated Units : 5750 units
Average Unit Price : (Total Amount Invested / Accumulated Units) = RM 0.52

What it means here is that as of March 2013, the investor is currently holding 5750 units worth RM0.52 each. If the investor decides to sell all units in April where the price is at...say RM0.70, the investor would have made a profit of:

= (RM0.70 - RM0.52) x 5750 units
= (RM0.18) x 5750 units
= RM1035 (profit)

What is shown above is an example of how the Dollar Cost Averaging method works. However, the unit trust prices which are used in the sample above is highly volatile and should not be accepted as a real life application. I must remind that the Dollar Cost Averaging method is not meant to be used for short term investment (3 years or lesser) due to the following reasons:
  • The volatility (price fluctuation) of a unit trust is not as aggressive as what was illustrated in the table above. 
  • This method is a basic protection against an economy downturn which could last between 1-3 years. When the economy is bad, unit trust prices (especially equity/stocks based unit trust) tend to drop, thereby allowing investors to accumulate more units, at a lower price using the same amount invested as compared to a bullish economy. In the previous sample table, you can assume that in Feb 2013, it is a bear market and in March 2013, it is a bull market. The units accumulated in Feb 2013 is priced at RM0.40 and also you would accumulate much more units as compared to March 2013 . By having more units at a lower price, it helps to bring down your average unit price, hence the term Dollar Cost Averaging!
  • This method works best in the medium to long term period (5 years or more) as it allows investor to accumulate substantial amount of units at different prices over differing economic situation. 
Key benefits for investor whom practice Dollar Cost Averaging:
  1. Investors need not worry about timing the purchase of unit trust as this method requires investors to purchase consistently at a fixed amount. This is also the reason why investors are allowed to utilized part of their EPF savings to invest into unit trust. Investing EPF savings every 3 monthly into unit trust over a period of 20-30 years is a clear indication of Dollar Cost Averaging method being put into practice.
  2. Most unit trust fund declare annual dividend to their investors. Dividend declared will then be reinvested into the unit trust fund by purchasing additional units. Amount of dividend obtained by an investor depends on how many units he/she is holding before the declaration of the dividend. Here's an example;
    1. Investor A has accumulated 100,000 units of Unit Trust Z using Dollar Cost Averaging method.
    2. Dividend declared by Unit Trust Z is RM0.05/unit
    3. Dividend enjoyed by Investors A : (100,000 units x RM0.05/unit) = RM5000* 
    4. The amount of RM5000* is then reinvested into the unit trust by purchasing additional units at the price after dividend has been declared.
    5. Investors A whom have consistently invested via Dollar Cost Averaging method has now increased the number of units he/she is holding due to the dividend being reinvested.
    6. The key role of Dollar Cost Averaging Method in this scenario is to help investor to accumulate units over a period of time which would then allow investors to enjoy more additional units from the reinvested dividend. Similar to an avalanche effect, the number of units will accumulated faster especially when the fund declares dividend again in the following year and the year after that... 
    • *Normally 20% tax is incurred upon the dividend, therefore actual dividend is RM4000
Actual Scenario of Dollar Cost Averaging Method being put into practice:
I believe an actual scenario of Dollar Cost Averaging method being put into practice is the best way to convince the "non-believers" about the effectiveness of this method. In this explanation, I had to painstakingly search for past unit prices as well as the annual dividend of a particular unit trust. 

This is an actual calculation to show the effectiveness of  Dollar Cost Averaging Method. The calculation takes into account the Service/Sales Charge Fee incurred everytime an investor makes an investment. 

Important key Data:
Fund : Top Performing Balanced Fund (I'ved decided to omit the name of the fund to avoid bias to a particular fund house)
Date of Fund Inception : 10 May 1999
Fund Price as of Fund Inception : RM0.50
Service Charge Fee : 5% for every investment

Method of Investment:
Initial Investment Amount on 10 May 1999 : RM1000
Quarterly Consistent Investment Amount : RM3000

Calculation:

Date
Price
Amount Invested
Sales Charge
Units Accumulated
Dividend Distribution
10-May-99
0.5000
1000
5%
1900

10-Aug-99
0.4483
3000
5%
6357

10-Nov-99
0.4697
3000
5%
6068

10-Feb-00
0.6867
3000
5%
4150

10-May-00
0.6377
3000
5%
4469

31-May-00
0.5759
0
0%
1992
0.050000
10-Aug-00
0.5244
3000
5%
5435

10-Nov-00
0.4903
3000
5%
5813

10-Feb-01
0.4634
3000
5%
6150

10-May-01
0.4271
3000
5%
6673

10-Aug-01
0.4528
3000
5%
6294

10-Nov-01
0.4376
3000
5%
6513

10-Feb-02
0.4901
3000
5%
5815

10-May-02
0.5567
3000
5%
5119

31-May-02
0.5031
0
0%
6290
0.043500
10-Aug-02
0.5021
3000
5%
5676

10-Nov-02
0.4863
3000
5%
5861

10-Feb-03
0.4894
3000
5%
5823

10-May-03
0.4827
3000
5%
5904

31-May-03
0.4792
0
0%
5871
0.027500
11-Aug-03
0.5126
3000
5%
5560

10-Nov-03
0.5432
3000
5%
5247

10-Feb-04
0.5490
3000
5%
5191

10-May-04
0.5472
3000
5%
5208

31-May-04
0.5122
0
0%
10497
0.041556
10-Aug-04
0.5103
3000
5%
5585

10-Nov-04
0.5263
3000
5%
5415

8-Feb-05
0.5457
3000
5%
5223

10-May-05
0.5306
3000
5%
5371

31-May-05
0.4870
0
0%
12638
0.038116
10-Aug-05
0.5097
3000
5%
5592

10-Nov-05
0.4918
3000
5%
5795

10-Feb-06
0.5052
3000
5%
5641

10-May-06
0.5254
3000
5%
5424

31-May-06
0.4897
0
0%
11974
0.029830
10-Aug-06
0.4962
3000
5%
5744

10-Nov-06
0.5407
3000
5%
5271

9-Feb-07
0.6378
3000
5%
4468

10-May-07
0.6808
3000
5%
4186

31-May-07
0.6377
0
0%
20935
0.058500
10-Aug-07
0.6478
3000
5%
4400

9-Nov-07
0.6816
3000
5%
4181

12-Feb-08
0.6884
3000
5%
4140

31-Mar-08
0.5807
0
0%
40584
0.090000
12-May-08
0.5988
3000
5%
4760

12-Aug-08
0.5612
3000
5%
5078

10-Nov-08
0.5168
3000
5%
5515

10-Feb-09
0.5273
3000
5%
5405

31-Mar-09
0.4744
0
0%
44335
0.065075
10-May-09
0.5081
3000
5%
5609

10-Aug-09
0.5551
3000
5%
5134

30-Sep-09
0.5089
0
0%
42117
0.056660
10-Nov-09
0.5224
3000
5%
5456

10-Feb-10
0.5196
3000
5%
5485

31-Mar-10
0.5245
0
0%
16254
0.019765
10-May-10
0.5262
3000
5%
5416

10-Aug-10
0.5356
3000
5%
5321

10-Nov-10
0.5626
3000
5%
5066

10-Feb-11
0.5816
3000
5%
4900

31-Mar-11
0.5487
0
0%
39053
0.045758
10-May-11
0.5470
3000
5%
5210

10-Aug-11
0.5465
3000
5%
5215

10-Nov-11
0.5414
3000
5%
5264

10-Feb-12
0.5746
3000
5%
4960

31-Mar-12
0.5464
0
0%
39759
0.041145
10-May-12
0.5484
3000
5%
5197

10-Aug-12
0.5747
3000
5%
4959

12-Nov-12
0.5913
3000
5%
4820

10-Feb-13
0.6167
3000
5%
4621

31-Mar-13
0.5819
0
0%
67673
0.067045
9-May-13
Total (RM)
166000
Total Units
655027


Summary of Calculation:
Initial Amount Invested (after deducting 5%)
RM 157,700
Total Units Held as of 9 May 2013
655027 units
Weighted Average Cost as of 9 May 2013
RM 0.2407533/unit
Price on 9 May 2013
RM 0.5920/unit
Amount gained if sold on 9 May 2013
RM 387,776.19
Net Profit
RM 221,776.19
% gained
133.60%
Total days invested
5113
Average Annual Return (approximate)
10.50%

Key points of this Calculation:
  • Apart from capital appreciation , the consistent dividend over the past 14 years has increased the number of units held by the investors as well as lowering the weighted average cost of units.
  • The total amount invested via Dollar Cost Averaging over the span of 14 years is RM157,700 and has returned a total of RM387,776.19 (net profit RM221,776.19) as of 9th May 2013.
  • Converting the returns of this fund into percentage, the average returns of this fund is 10.50% per year or 133.60% in raw returns.
Performance comparison of this fund against EPF using Dollar Cost Averaging method:
Assuming that we contribute the same amount into EPF on a consistent basis, the returns of EPF over 14 years is shown below:

Initial Amount
RM 1000
Annual Contribution
RM 12,000
Avg EPF Dividend Rate
6%
Total Amount Invested
RM 178,000
Amount gained if redeemed on 9 May 2013
RM 289,920.70

Net Profit
 RM 111,920.70
% gained
62.88%

Comparing the performance of both EPF and this fund, the figures are self explanatory. The percentage gain of EPF (62.88%) is dwarfed by the percentage gain of this fund (133.60%).

Summary
It is clear that the Dollar Cost Averaging method being applied into unit trust investing is an effective strategy to grow your money passively on a long term basis. Despite the 5% service charge, this fund is still able to generate outstanding returns by applying this method. 

The fund used in this calculation is in fact a balanced fund whereby 50% of its asset are invested into equity while the remaining 50% is invested into fixed income, bond, etc. The potential of earning can be more if a pure equity fund is chosen to apply Dollar Cost Averaging method.

However, I must stress that not all unit trust fund is able to generate performance such as this. An investor should be selective and decide on the fund that is able to generate great returns according to your risk profile. I would advise to read up on the fund's prospectus, check the historical performance via fund fact sheet and consult a reliable unit trust consultant before deciding on which fund to apply the Dollar Cost Averaging method.

Cheers and Happy Investing!

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