I've tried to outline how much should be invested each month as a proportion of the total fund value at any time in the FAQ on the web site.
Perhaps a relatively simple explanation here to clarify.
Two funds both average 10% each year over three years with the first achieving this by 0%, 0% 30% and the second 10%, 10%, 10% in each of the years.
The first has an end gain of 30% whereas the latter has a end gain of 33.1%. The benefits of compounding have produced a 3.1% higher return over the three years.
If, as in the case of our strategy, returns tend to be along the lines of the former rather than being more consistent year after year, we can use a 'virtual' fund value.
Let's say we have 100 to invest and we anticipate a 10% gain average. After the first year we increase our virtual fund value to 110 even though a 0% gain was achieved. Again in year 2 we increase the virtual fund to 121 representing another 10% increase, even though the fund gained 0% in that year. In the third year a 30% gain arises - producing a profit over the three years of 30% on 121 = 36.3%. In contrast the regular 10% each year gain fund would stand at a profit of 33.1%. We've an additional 3.2% more than the more regular fund. However we would have leveraged (borrowed) a total of 31 over the three years. At a cost of say 7% to make such borrowings, that's a 2.17, bring that gap down from 3.2% to 1.03%. Despite less regular returns but comparable average returns, we've out-performed the regular less volatile returns across the three years.
Providing our virtual fund growth rate is set at around the longer term actual growth rates achieved, then even though we have less regularity of returns on a year by year basis we can still achieve around comparable actual gains overall.
Typical of me, so clear in my own mind yet find it so difficult to simply describe to others. Perhaps a volunteer to re-write the web site content would be of benefit - any takers?
Regards.
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