Drip-Feeding Makes the Difference

By Mary Holm

Tuesday 5th December 2000

It's the beginning of 1995, and you've put $1000 into a certain UK investment trust. A year later it's worth $907; in another year, $658; in another, $359. Do you bail out?

Never. In one more year, you're at $444. Then, a year later, it's $3449.

No, I didn't forget a decimal point. The value of an investment in Invesco Japan Discovery rose more than seven-fold last year. You never know what lies around the corner.

But that's not why I'm writing about the scarily volatile Invesco Japan.

I've been looking at the fund's performance because of a letter I received from a "perplexed" Johnsonville reader.

He didn't understand what I was trying to say in my last column, and others might also be confused. It's an important message, so let's have another go at it.

The column was about dollar cost averaging - a bonus you get if you invest the same amount into a share or share fund on a regular basis.

Because you get more units when the price is low, you end up paying less per unit than the average price over the period.

Let's say you invest $300 a month. In the first month, the price is $10, so you get 30 units. Next month, at $30, you get just 10 units. In the third month, at $20, you get 15 units.

The average of $10, $30 and $20 is $20. But you've got a total of 55 units for $900. That amounts to $16.36 a unit.

As I said last time, the more volatile the price, the better dollar cost averaging works. You get a great many really cheap units, which heavily outweigh the expensive ones.

To illustrate this, share brokers Craig & Co looked at $200-a-month investments into various UK investment trusts for five years ending January 31 this year. Here's how I wrote up the results:

"The three fastest growing funds it studied were Electra and Gartmore European, which both grew by 37 per cent a year, and Invesco Japan Discovery, which grew by 33 per cent a year - all extremely good returns.

"While the Japan fund had slightly slower growth, its returns were more volatile than Electra and Gartmore. And this made a huge difference."

The Electra investment grew to $26,800; Gartmore to $24,700; Invesco Japan to almost $54,000.

This bothered our perplexed reader. "What am I missing here?", he wrote. "If one gets more back from one fund than from another, how can both funds be said to have grown by the same extent?"

What you're missing is that growth figures are calculated assuming we put in lump sums at the beginning. Here, though, we're drip-feeding money. And that changes everything.

At this point I should apologise for saying the funds grew by 37 or 33 per cent a year. To be more precise, those were five-year returns expressed per annum - a sort of average.

In fact, the annual returns varied widely. They ranged from 15 to 54 per cent for Electra, 15 to 78 per cent for Gartmore, and minus 45 to 677 per cent for Invesco Japan.

Invesco Japan was by far the most volatile. And, as I said above, that means investors who drip-fed money into it benefited much more from dollar cost averaging than those who went into Electra or Gartmore.

As Invesco Japan's value fell in the first three years, investors got more and more really cheap units for their fixed amount. Then, when the price zoomed, they had many units at the new high value.

In drip-feed situations, volatility can be good.

Mary Holm is a freelance journalist and author of "Investing Made Simple", commissioned by the New Zealand Stock Exchange to write an independent personal investment column. She can be reached by E-mail at maryh@journalist.com. Sorry, but she cannot respond directly to readers.

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