Buying low and selling high is easier said than done, thanks to volatile equity markets. Timing the market is tough. That’s why experts suggest retail investors choose a systematic and unemotional way of investing in equity. Rupee cost averaging and value averaging are two such popular methods.
Rupee Cost Averaging (RCA): Most investors are familiar with RCA – thanks to popularity of SIPs (Systematic Investment Plan). Here, the investor invests a fixed amount regularly – say every month. When NAV prices go up (or down), lesser (or more) units are bought which in turn reduces overall unit cost.
With Value Averaging, however, the invested amount varies. First, you fix a long-term portfolio target (in value). You use this to arrive at monthly or quarterly “value” targets. It is essentially your ‘value path’. Investors thereby adjust their portfolio's growth by systematically adding or removing just enough to meet their long-term goals.
Suppose you opt for RCA and invest Rs 10,000 every quarter. When NAV prices go up to Rs 120 in Q2, you buy lesser units (83.3) and buy more units (125) when NAV falls to Rs 80.
RCA is a much simpler way to invest as you need not track the portfolio. Value averaging, though, requires you to periodically calculate the portfolio value and determine your investment.
In Value averaging, you determine the value path by growing your portfolio – by say Rs 10,000 every quarter. At the end of Q1, when NAV is Rs 100, you would buy 100 units by investing Rs 10,000. By the end of Q2, your earlier investments would have soared to Rs 12,000 (at an NAV of Rs 120). So, you are only Rs 8000 short of the Rs 20,000 value target for Q2.
So, you invest only Rs 8000 to buy additional 66.7 units. In Q3, with the NAV dipping to Rs 80, your overall portfolio shrinks to Rs 13,333. So, you invest Rs 16,667 in Q3 to bring the portfolio value to the target amount of Rs 30,000. Lastly, when NAV climbs to Rs 100, you invest only Rs 2,500 to reach the Q4 portfolio target of Rs 40,000.
Which investment approach is better? Read the pros and cons.
RCA is a much simpler way to invest as you need not track the portfolio. Value averaging, though, requires you to periodically calculate the portfolio value and determine your investment. If it’s ahead of your value path, you might even have to sell. Most mutual funds and investment portals automate SIP investments into mutual funds. However, you might have to do VA yourself.
Investors using the Value Averaging approach have to make higher investments when NAVs are low and vice versa. However, during market downturn, it might be a challenge for most investors to garner resources without having deep pockets. It becomes a difficult proposition once the portfolio value increases – calling for larger investments to keep it in line with value strategy.
Both RCA and Value Averaging call for disciplined investing. While both the approaches work in volatile markets, to reap its full benefits you need to invest over 10 years or more.
While Value Averaging has the added advantage of keeping you focused towards your goals, it calls for a hands-on approach – with ready cash on the sidelines. Retail investors are better off choosing SIPs.