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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