How to Make the Sun Shine on a Gloomy Day
Just like seeing the sun shining on a gloomy day, it is also a tough concept to comprehend getting excited about seeing your investments decline in value. For a long term investor who is still contributing to an RRSP, non-registered account, or RESP, a decline in the market can help increase future returns. An example of how this works is called “dollar cost averaging”.
I am going to compare two different scenarios with different investments. With each scenario, we will invest $100 on the first day of the month for a year. Both investments will start at $10 per share and both will finish the year (December 31st) with a value of $13 per share.
Investment “A” will increase in value each month during the year before reaching $13 per share at year end. This will produce a profit (market price at year end minus cost) of $179.40.
A |
Jan 1 |
Feb 1 |
Mar 1 |
Apr 1 |
May 1 |
Jun 1 |
Jul 1 |
Aug 1 |
Sep 1 |
Oct 1 |
Nov 1 |
Dec 1 |
| Investment | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 |
| Share Price $ | 10.00 | 10.25 | 10.50 | 10.75 | 11.00 | 11.25 | 11.50 | 11.75 | 12.00 | 12.25 | 12.50 | 12.75 |
| # of Shares | 10.9 | 9.76 | 9.52 | 9.30 | 9.09 | 8.89 | 8.70 | 8.51 | 8.33 | 8.16 | 8.0 | 7.84 |
Investment “B” will increase in value early in the year, but then decrease in value during the year to as low as $7 a share before increasing to $13 per share at year end. This will produce a profit of $481.05.
B |
Jan 1 |
Feb 1 |
Mar 1 |
Apr 1 |
May 1 |
Jun 1 |
Jul 1 |
Aug 1 |
Sep 1 |
Oct 1 |
Nov 1 |
Dec 1 |
| Investment | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 | $100 |
| Share Price $ | 10.00 | 11.00 | 10.00 | 9.00 | 8.50 | 8.00 | 7.00 | 8.00 | 9.00 | 10.50 | 11.00 | 12.00 |
| # of Shares | 10.00 | 9.09 | 10.00 | 11.11 | 11.76 | 12.50 | 14.29 | 12.50 | 11.11 | 9.52 | 9.09 | 8.33 |
Without doing your own calculations, you might be wondering why the profit is so much more for Investment “B” compared to “A” when they have the same ending share price. The answer is that in months where the share price is below the initial price of $10 per share, the investor will be able to purchase more shares. Once these shares increase in value, the total value of the investment increases at a higher rate. This is due to there being more shares.
The benefits of contributing in either of these investments are magnified when compared to investing a lump sum at the end of the year. An investor purchasing $1,200 at the end of the year will not be able to take advantage of the lower share values during the year. They will not have any immediate profit from investing all at one time. Investing on a regular basis can also eliminate having to guess when it is the right time to purchase.
Dollar cost averaging is an effective way of taking advantage of the market declines to help increase your investment value in the long run.
August 13, 2008
