The secret of Dollar Cost Average making profits

Before we introduce fund investment, I wrote two articles:

The purpose of these two articles are to tell that investment techniques, such as FA (Figure Analysis) and TA (Technical Analysis) are not paramount. We could read through the sweeping monk in Jin Yong’s novels (天龙八部) and understand this point. There is no need to stare at computer screens to get real time stock price, but to read more books, listen to storytelling, e.g. Three Kingdoms (三国演义), Water Margin (水浒传). I suppose audio is only in Chinese.

Dollar Cost Average is one type of long-term investment. In general, the average period is 3-10 years, or even longer. Now, we calculate how Dollar Cost Average gains profits by using mathematics we learned from elementary school. To make it simple, let’s take a simple example.

E.g. Fund A, the market price on January 03, 2017 is $100. Investor B is a lover of Dollar Cost Average and buys $100 Fund A on 3rd of every month. One thing to remember, adhering discipline is the top one advice!

When February 03,2017 comes, fund A will drop 50%. There could be many reasons, e.g. natural disasters, terrorism, political turmoil, etc.

Investor B is a principal man and he will buy Fund A with $100 without any hesitation.

Date Price ($) Amount of investment/month ($) Shares
Jan-3 -2017 100 100 1
Feb-3-2017 50 100 2

There are some basic questions we need to answer. Your reply will tell how much you know about Dollar Cost Average.

  1. Now, how much is the total fund value of investor B?

A: 1×50 +2×50 = $150

  1. How much is his/her total loss?

A: 200 -150 = $50.

  1. How much is the percentage of loss to total investment?

A: 50/200 = 25%. Please note: The market is down 50%, investor B only has 25% loss.

  1. How much is the average fund price that investor B owns, now?

Most people would say it is $75, because (100+50)/2 = $75.

No! It is wrong reply. Currently, investor B’s fund A price is 200/3= $66,7. It even lower than $75.

  1. How much should fund A go up for investor B to get some profits?

Someone says it is 50% because market down is 50%.

Wrong! Fund A unit price reaches above $66,7, then investor B can gain profits. The percentage of going up is (66,7-50)/50=33,3%. When it drops 50%, once it rises 33,3%, then investor B can gain profits. The is the secret of Dollar Cost Average because your investment is averaged along with market fluctuation.

  1. If market returns to the previous level before dropping, how much should investor wait for rising? Somebody says 50%.

NO! It should rise 100%, then Fund A price can rise $50 price to $100.

  1. How much percent does investor B gain when unit price goes back $100?

Someone thinks it is balanced.

NO! Investor B gains $100. 3×100-200=$100. Profit ratio is 100/200=50%.

Investor B only needs to wait; nothing need to do. Investor B waits market recovering to previous level, then he/she will gain 50% margin.

Rich growth is multiplied by time!

Image source: https://en.wikipedia.org/wiki/S%26P_500_Index#/media/File:S_and_P_500_chart_1950_to_2016_with_averages.png

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