How (Regularly) Investing in Mutual Funds Works
Mutual funds in Slovakia are growing in popularity. It is offered by banks, insurance companies, management companies and many other intermediaries. More often than the one-time investment we encounter the concept of regular investment in mutual funds.
An ordinary person who defrays from his / her wages often has no other choice but to invest in mutual funds on a regular basis. He simply does not have the money at eleven and can not make one big one-off investment. Therefore, it invests monthly because it has a regular monthly income.
Regular investment is a very good tool to gradually build up these larger amounts and avoid some risks. However, this is largely due to the fact that the time goes by any regular investment, the investment becomes one-time.
Investing in mutual funds
To put it simply, it’s about buying shares. A unit certificate is a security with which the unit-holder’s right is associated with a corresponding share in the unit trust’s assets and the right to participate in the proceeds from such assets.
The Unit has its price, which varies depending on what is happening in the financial markets. The price of a share certificate may fall as well as rise. The value of the asset is determined by the number of units purchased multiplied by their current price.
Unit price averaging effect
The method is suitable to mitigate the fluctuation of unit price. You buy shares in both a downturn and a growth time. If markets grow, your investment grows with them, and if markets fall, you buy less.
We will first show you in situations where the market has experienced a significant decline and subsequently increased. On the graph below, you can see color-coded points, each representing a unit price. The yellow point is € 5, € 4 in green, € 6 in blue, € 3 in red, € 7 in purple and € 8 in gray.
At the beginning, you bought 20 units (hereinafter referred to as PJ) in yellow for 100 €. Markets dropped and PJ price dropped to € 4 at the green spot where you bought 25 PJ. Subsequently, it rose to a price of € 6, where almost 17 PJ were purchased. Then the markets fell sharply and you bought up to 33 PJ at the red spot for € 3. In the purple spot, just over 14 PJ for the price of 7 €. At the gray point, you bought 12.5 PJ for 8 €.
Your investment ends here. The resulting unit price is € 8 and the total number of units you purchased is 121.79 units. The resulting value of your investment is € 974.29 versus € 600. Despite a temporary decline of almost 30% in the red spot, you earned a lot.
This drop has been beneficial to you since it has allowed you to purchase units at a low price. Many people make a mistake here. It is enough that the value of their investment is lower than their deposit for and while they are not willing to put in more money, in the worst case all the money is collected and the loss is realized.
This is the case when the curve of your investment evolved in the form of “V”. This means that markets first fell and then grew sharply. In such a situation, it is advantageous for you to have similar drops and therefore cheap purchases as much as possible. In this situation, you even earn more on a regular investment than if you had invested the entire amount at one time. Thus, by averaging the share you earned more.
How will price averaging result in a loss?
Averaging the unit price does not necessarily mean that you always end up with your investment in the bus. It all depends on what happens in the markets. Let’s say you’re not going to grow as it was in the previous example, and you’ll have to stop investing for some reason.
In the following table, you can see individual months, unit prices in individual months and the number of units purchased for € 100. During these 12 months, you have gradually added € 1200 and the unit price has gradually decreased by 30%.
A total of 139.28 units were purchased. The unit price at the end of the year was € 7.35 and the investment value was € 1023.72. This represents less than you inserted. Even though you have not earned money, averaging the share price has greatly helped you to protect a large portion of your money.
If instead of investing € 100 a month on a one-time basis in January, you would buy 114.28 PJ (1200: 10.5). Less than when you deposited this money regularly for 12 months and bought it up to 139.28. The value of your investment would be about € 840 (€ 114.28 x € 7.35), which corresponds to a market decline of 30%.