Regular Saving Plan Back Testing Result
Assuming that you started investing in the Straits Times Index (STI) 10 years ago, buying $3000 worth of stocks every month without considering the price, how much will your returns per annum be?
We can calculate our return per annum for this past 10 years by using the historical prices of STI for the past 10 years and work from there. The results of the calculation are as shown in the table below.
Before we begin to analyze the results from the table, let us first explain some of the terms used in the table above.
Total Amount Invested:
This is the total amount of cash both invested and spend by you on this investment. Assuming you set aside $3000 every month to invest in STI and the commission is $25, the amount of cash you invest and spend every month is $3025 and the amount you invest and spend every year is ($3025 X 12) = $36 300 every year. However, in the case where there are dividends to be collected on a particular month, you will reinvest the dividends earned that month which will in turn, reduce the amount you contribute every month by the amount of dividends earned. Therefore, the amount of cash you invest and spend that month will be $3025 – Dividends Earned.
This is the amount that you will receive if you sell all the unit of stocks that you had accumulated up till the point of sale. This value is calculated by multiplying the number of units that you currently hold with the price of each unit at the time of sale.
Internal Rate of Return:
The Internal Rate of Return (IRR) for an investment is the percentage rate earned on each dollar invested for each period it is invested. IRR gives us the means to compare alternative investments based on their yield.
Now that we have explained the terms used in the table, we can begin to analyze the results of our calculation. As shown in the table above, the IRR tends to fluctuates from year to year. However, the average IRR across the year is calculated to be 7.2%. This demonstrates to us that 7.2% internal rate of return per annum is achievable using this strategy despite the lack of active management of the portfolio.
Furthermore, as shown in the table above, the IRR for certain years are less than favorable with it being
-16.6% in 2008 and 2.1% in 2015. This shows that in order to realize higher returns on your investment, it is likely that you must have the capacity to wait long term. You are likely not able to choose your own exit point since exiting early could likely lead you to have less than favorable returns on your investment.
Another important point to note from the result above is that, if you are able to time the market properly, there exists the possibility of you earning even higher returns than when you take the more hands off approach. As shown in the table above, there are certain years where the IRR is significantly higher than the other years due to higher stock prices during those years. If you are able to sell all the stocks which you have accumulated when the prices are high and buy them again when prices plummets, it is likely that you can achieve an even higher return per annum than 7.2%
In conclusion, simply by following the strategy of investing a fixed amount into STI every month with disregard to the price of the stock and holding it over an extended period of time, it is possible for you to achieve a return of at least 7% return per annum. However, in order for you to realize this 7% return per annum, it is important for you to be able to ride out the ups and downs of the market over the long-term, as exiting early could result in achieving less than desirable returns.