A client asked me recently about his mutual fund investment. At that time the market value of his investment was below the price he had initially paid. He wanted to know where the difference between the purchase price and market value was. His words were, “In whose pocket was his lost money?”
This is an excellent way to open the discussion on the importance of the share price and market value of an investment.
When you purchase mutual funds your initial investment buys you a certain number of shares, for example, 1000 at $5. Unless you sell or redeem your investment you will always have 1000 shares. No matter if their market value is $3000 or $10000 you still have the same number of shares. In fact if you hold you investment long enough you will most likely end up with more than 1000 shares. The reason is if the mutual fund has enough profit to pay out to shareholders (a distribution) this profit is usually reinvested in your portfolio. This gives you more shares. The more shares you have the better your chances of making money.
To summarise: Over most of the time period you are investing the market value is not as important as how many shares you have. The market value of your investment becomes more important closer to the time you will need your money eg retirement. This is where my value to you will be proven. It is my duty to be monitoring your investment so that at the right time recommendations can be made so you will be able to keep the maximum profit.
The best way to increase the amount of shares you own is to take advantage of the roller coaster market. You do this by dollar cost averaging. Dollar cost averaging lets you get your shares on sale. We all like sales right? Dollar cost averaging can best be illustrated by the following story:
A couple have $700 to invest in cattle to start a herd on their farm. As they fear the market for cattle may go down they decide to invest $100 a month for 7 months instead of investing the $700 all at once.
1st month: The price per cow is $100 so they can buy one cow.
2nd month: The price has dropped to $50 per cow. The couple is happy to be able to buy 2 cows with their $100.
3rd month: This month the cow price has fallen to $25 per cow. Now the farmers are worried but decide to stay with their plan. Their $100 buys 4 cows.
4th month: The price for cows has continued to decrease to $10 per cow. The couple is concerned and doubtful about continuing to invest. They reluctantly invest their $100 in 10 cows.
5th month: The price has recovered to $25 per cow, and they are able to buy 4 cows.
6th month: The price continues to rise, and the couple confidently buys 2 cows at $50 each.
7th month: The cow price is now $100 again, and the couple spends their last $100 on one cow.
The couple bought cows during every market cycle. They ended up with a herd of 24 cows instead of 7 if they had spent all their money at once. The cost per cow by spending over a period of time was about $29 versus $100 if they had spent it all in the first month.
By having 24 cows instead of 7 they will make a lot more profit when the price of cows increases even further.
The only way they could have had more cows would have been to wait buy to all of them when they were $10. However it is very difficult to know when is the best time to buy.
Dollar cost averaging removes the need to make that decision.
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