Value averaging helps achieve investment goal

Value averaging is an investing strategy that works like rupee cost averaging in terms of steady monthly contributions. In value averaging, the investor sets a target growth rate or amount for his portfolio each month, and then adjusts the next month's contribution according to the relative gain or shortfall made on the original asset base.

The main goal of value averaging is to acquire more shares when prices are falling and fewer shares when prices are rising. This happens in rupee cost averaging as well. Over many annual timeframes , value averaging can produce higher returns.

One major potential pitfall with value averaging is that as an investor's asset base grows, the ability to fund shortfalls can become too large to keep up with. One option is to allocate a portion of assets to fixed income funds, and then rotate the corpus in and out of equity holdings as required by the monthly targeted return. This way, instead of allocating cash in the form of new funding, it can be raised in the fixed income portion and allocated in higher amounts to equity holdings as needed.

Have ample funds during bear market phase:

Identifying the top and the bottom of the market is impossible . However, varying the amount of money to be committed could help investors .

Most investors are familiar with the concept of rupee cost averaging or systematic investment plans of mutual funds, where you invest a fixed sum at regular intervals . Value averaging is a more evolved concept. Here, the investor is expected to adjust the amount to be invested in tandem with the direction of the market - up or down - to achieve a prescribed value of the fund.

Investors should put in more money when the markets are at a low and park their funds in safe instruments when the markets are volatile. It must be borne in mind that the same money will be used by investors when equities fall. It is to be noted that one needs to have ample funds during a bear market phase.

Invest when market shows a downturn:

When the stock market is in a downturn, it is a good practice to increase contributions to your investment accounts, thus buying more shares at a lower price. When the market has provided a high return, it makes sense to scale down contributions, buying fewer shares at the higher prices.

For example, suppose an account has a value of Rs 1,000 and the goal is for the portfolio to increase by Rs 100 every month. If, in a month's time, the assets have grown to Rs 1,010, the investor would fund the account with Rs 90 worth of assets. In the following month, the goal would be to have account holdings of Rs 1,200.

If in the third month the value is Rs 1,310, nothing is to be invested. This pattern continues to be repeated in the following month.

Tips for investing strategically: In this illustration, one should invest the Rs 100 that is not being invested in the third month due to a rising market in a safe instrument or keep it in a savings bank account to earn interest rather than spend it. You invest more when the prices fall and less when they rise. In other words, you buy more when the prices are low and you end up investing less when the markets peak.

With value averaging, you first figure out how much money you will need to accumulate for a goal such as retirement . Then, based on the annualised returns you expect to earn on your investments , you figure out how much you must invest each month to achieve that goal.

You should go through this process each month. In months where you fall behind , you would add to the amount you invest each month. And in months where your returns are higher than expected and your portfolio's value gets beyond where it needs to be, you would scale down your monthly investment , or even possibly end up selling some shares.

Plan investments systematically:

There are various ways to carry out this strategy. Instead of adjusting your investment amount each month, you could recalculate it every six months or every year. It provides a much more systematic way of reaching a specific rupee goal.

Since you are monitoring the value of your portfolio, you know whether you are on track and, if not, exactly what you need to do to get back on track. If the market goes into a prolonged slump, or if you simply overestimate the returns you can earn, you could end up having to make very large contributions to keep your account value on track.

Also, it does not give you any real control over the returns you earn, which is determined by the markets. The strategy may be able to lower the volatility of your portfolio somewhat.