Sunday 3 November 2013

Dollar Cost Averaging Works Best with Volatile Stocks/ Unit Trusts

I have 2 unit trusts in my Supplementary Retirement Scheme account. One is an equity unit trust (LionGlobal Infinity Global Stock Index Fund) while the other is a balanced unit trust (UOBAM Growth Path 2040). They are invested regularly on a monthly basis for the past 6 years. The relative performance of the 2 unit trusts since my first investment 6 years ago is shown in the chart below.

Relative Performance of Unit Trusts Since 1st Investment

From the chart, we can see that the performance of the balanced unit trust is more stable than that of the equity unit trust. During the Global Financial Crisis, it dropped to 60% of the initial investment price while the equity unit trust dropped even lower to around 45%. Subsequently, the balanced unit trust recovered to the 80% - 90% level and remained there for 3.5 years until February this year. In contrast, the equity unit trust recovered only to the 60% - 70% level during the same period and rising to the 80% - 90% level only recently. Throughout this period, the performance of the equity unit trust is worse that that of the balanced unit trust.

Yet, guess which of the unit trusts performed better in my portfolio? Surprising, it is the more volatile equity unit trust that performed better. It has returned 26% over the 6-year period compared to only 8% for the balanced unit trust.

The main reason for the better portfolio performance of the equity unit trust is because through regular monthly investment, the plan performs Dollar Cost Averaging (DCA). DCA buys more units when the price is lower and less when the price is higher. Since the equity unit trust has dropped more than the balanced unit trust, more units were accumulated. Hence, when the price recovers, the equity unit trust performs better, even though its price is consistently lower than that of the balanced unit trust throughout this period.

To conclude, Dollar Cost Averaging performs better with volatile stocks/ unit trusts than more stable ones.

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