Some individuals assume that if they regularly invest in a fund linked to stock markets, their investment will perform better if there is a steady growth rate.
This is not necessarily the case and this can be demonstrated through an investment concept known as unit cost averaging theory.
Unit cost averaging means that as a regular premium investor, you can take advantage of fluctuating or even depressed unit prices. So how does unit cost averaging maximise investment returns?
The example below illustrates the concept.
At the beginning of each quarter for three years, an individual invests USD1,000.
The graph shows a simple steadily increasing market. You can see how many units the investor would have bought at each price and that, in a market which grew steadily by 55% over the period, a total of 23% was achieved through regular investments.
This may seem obvious that an investor should receive a reasonable return from an upwardly moving market. However, stock market levels can fluctuate leading to highs and lows.
So what happens to regular contributions in a fluctuating market?
The graph shows a market fall and then rise, with the unit price still not recovering to its original value.
Again, you can see how many units the investor would have bought at each price, even with the unit price dropping by 5% over the three years. An investment of USD1,000 per quarter for three years would have received a total 13% return.
How is this possible?
You can see that while the unit price was falling, the investor was able to purchase more and more units with the same USD1,000 per quarter.
This meant that when the market took an upward swing, the investor owned more units than if he had invested the total USD12,000 at the beginning of the three year period, which led to higher gains in the last eighteen months.
So what is likely to happen in a fluctuating market, with an upward trend?
The graph shows the unit price falling and rising, with the units bought rising and falling respectively.
The market as a whole has returned 55% over the period.
The affect of a fluctuating unit price has meant the investor has ended up with even more units
than in a steadily increasing market, receiving a total return of 28%.
We can see that in order to reap benefits from the stock markets an individual need not necessarily
have a large lump sum to invest today.
A series of regular investments can return positive gains in various market scenarios.
Therefore, over the long-term, under the usual market conditions of fluctuating markets, an investor can take advantage of the benefits of unit cost averaging through regular investments into a unit-linked investment.
Key points
- Positive returns over many market scenarios.
- Obvious benefits for clients with regular savings/premiums.
- Greater returns can be achieved through fluctuating market conditions with an upward trend.