Value Cost Averaging Vs Rupee Cost Averaging
One of most basic tenets of stock market investing is Buying low and Selling high, however this requires a close monitoring of the stock prices and a disciplined approach towards investment. Most of the times, fear and greed have a stronger impact on an investor rather than an investor's long term investment goals. Which is why most of times, people buy when the markets are high and sell when the markets are low. Also timing the market is very difficult.
The post below will compare two investment techniques viz.. Value Cost Averaging (VCA) and Rupee Cost Averaging (RCA)
First we will look at Value Cost Averaging (VCA). VCA is an investment technique wherein investments are made at regular intervals and is similar to Systematic Investment Plan (SIP) investment method. However in case of VCA, the contributions that are made are dependent or basically fluctuate based on the market value of the underlying securities / fund. VCA ensures that the portfolio value increases by a pre-defined amount at every installment period regardless of whether the market is up, down or range bound.
For instance, let's say if an individual has a target of 15% annual return and he invests Rs 10000 every month, that means he expects his money to grow as follows
1-Jan-2012 - 10,000
1-Feb-2012 - 20125
1-Mar-2012 -30377
1-Apr-2012 - 40757
1-May-2012 -51266
...
If we look at the above calculations, the individual will evaluate the investment value then calculate where he should be in the next month and then invest only the difference.
For example if the investment value at the end of the third month is Rs 35,000, however it should be Rs 40,757 then the individual will invest Rs 5,757.
In VCA technique, the investor sets a predetermined value of the portfolio in each future time period. The investor then buys or sells based on whether the portfolio value is reached or not. So in case of market declines, the investor ends up buying more units and in case of up trends, the investor either ends up buying less or even redeeming the units to meet the pre-determined porfolio value.
We will now look at the second investment technique i.e. Rupee Cost Averaging (RCA).
RCA is an investment technique which involves investing a fixed amount every month Irrespective of the portfolio value. RCA technique does not take into account the market movements and hence if a person has set an SIP to purchase units worth Rs 1,000 every month, then very month Mutual Fund units worth Rs 1,000 will be purchased irrespective of whether the market is in up or down.
Since we have understood the concept of VCA and RCA, let's present the same through a graphical illustration with an example wherein an individual wants to grow his portfolio by Rs 1,000 every month from January to November.
In the above example, VCA ensures a steady increase in the portfolio by Rs 1,000 every month irrespective of market conditions. VCA also mandates investing variable amounts i.e. investing more when the markets are down and less when the markets are up.
Since we have seen both the investment techniques, we will now look at the difference between VCA and RCA
As I write this post, HDFC has introduced an option, HDFC Swing STP which works on the VCA principal. I have covered HDFC Swing STP in my Blog - http://swingstp.blogspot.in/
The post below will compare two investment techniques viz.. Value Cost Averaging (VCA) and Rupee Cost Averaging (RCA)
First we will look at Value Cost Averaging (VCA). VCA is an investment technique wherein investments are made at regular intervals and is similar to Systematic Investment Plan (SIP) investment method. However in case of VCA, the contributions that are made are dependent or basically fluctuate based on the market value of the underlying securities / fund. VCA ensures that the portfolio value increases by a pre-defined amount at every installment period regardless of whether the market is up, down or range bound.
For instance, let's say if an individual has a target of 15% annual return and he invests Rs 10000 every month, that means he expects his money to grow as follows
1-Jan-2012 - 10,000
1-Feb-2012 - 20125
1-Mar-2012 -30377
1-Apr-2012 - 40757
1-May-2012 -51266
...
If we look at the above calculations, the individual will evaluate the investment value then calculate where he should be in the next month and then invest only the difference.
For example if the investment value at the end of the third month is Rs 35,000, however it should be Rs 40,757 then the individual will invest Rs 5,757.
In VCA technique, the investor sets a predetermined value of the portfolio in each future time period. The investor then buys or sells based on whether the portfolio value is reached or not. So in case of market declines, the investor ends up buying more units and in case of up trends, the investor either ends up buying less or even redeeming the units to meet the pre-determined porfolio value.
We will now look at the second investment technique i.e. Rupee Cost Averaging (RCA).
RCA is an investment technique which involves investing a fixed amount every month Irrespective of the portfolio value. RCA technique does not take into account the market movements and hence if a person has set an SIP to purchase units worth Rs 1,000 every month, then very month Mutual Fund units worth Rs 1,000 will be purchased irrespective of whether the market is in up or down.
Since we have understood the concept of VCA and RCA, let's present the same through a graphical illustration with an example wherein an individual wants to grow his portfolio by Rs 1,000 every month from January to November.
| Illustration of difference between VCA and RCA | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Value Cost Averaging (VCA) | Rupee Cost Averaging (RCA) | |||||||||||||
| Transfer Date | NAV Per Unit (1) | Target Market Value (2) | Market Value Of Holdings Before Investment (3) | Amount To Be Invested (4=2-3) | Units Bought / Redeemed (5=4/1) | Cumulative Amount Invested (6) | Cumulative Units (7) | Net Average Cost Per Unit (8=6/7) | Amount To Be Invested (9) | Units Bought (10=9/1) | Cumulative Amount Invested (11) | Cumulative Units (12) | Net Average Cost Per Unit (13=11/12) | Market Value (14=12*1) |
| 1-Jan | 10 | 1,000 | 1000.00 | 100.00 | 1,000 | 100.00 | 10.00 | 1,000 | 100.00 | 1,000 | 100.00 | 10.00 | 1,000 | |
| 1-Feb | 12 | 2,000 | 1,200 | 800 | 66.67 | 1,800 | 166.67 | 10.80 | 1,000 | 83.33 | 2,000 | 183.33 | 10.91 | 2200 |
| 1-Mar | 11 | 3,000 | 1,833 | 1,167 | 106.09 | 2,967 | 272.76 | 10.88 | 1,000 | 90.91 | 3,000 | 274.24 | 10.94 | 3017 |
| 1-Apr | 9 | 4,000 | 2,455 | 1,545 | 171.67 | 4512 | 444.43 | 10.15 | 1,000 | 111.11 | 4,000 | 385.35 | 10.38 | 3468 |
| 1-May | 7 | 5,000 | 3,111 | 1,889 | 269.86 | 6401 | 714.29 | 8.96 | 1,000 | 142.86 | 5,000 | 528.21 | 9.47 | 3697 |
| 1-Jun | 8 | 6,000 | 5,714 | 286 | 35.75 | 6,687 | 750.04 | 8.92 | 1,000 | 125 | 6,000 | 653.21 | 9.19 | 5,226 |
| 1-Jul | 10 | 7,000 | 7,500 | -500 | -50 | 6,187 | 700.04 | 8.84 | 1,000 | 100 | 7,000 | 753.21 | 9.29 | 7,532 |
| 1-Aug | 12 | 8,000 | 8,400 | -400 | -33.33 | 5,787 | 666.71 | 8.68 | 1,000 | 83.33 | 8,000 | 836.54 | 9.56 | 10,038 |
| 1-Sep | 13 | 9,000 | 8,667 | 333 | 25.62 | 6,120 | 692.33 | 8.84 | 1,000 | 76.92 | 9,000 | 913.46 | 9.85 | 11,875 |
| 1-Oct | 14 | 10,000 | 9,692 | 308 | 22 | 6,428 | 714.33 | 9.00 | 1,000 | 71.43 | 10,000 | 984.89 | 10.15 | 13,788 |
| 1-Nov | 15 | 11,000 | 10714 | 286 | 19.07 | 6,714 | 733.40 | 9.15 | 1,000 | 66.67 | 11,000 | 1051.56 | 10.46 | 15,773 |
| Total Units Purchased = 733.40 | Total Units Purchased = 1051.56 | |||||||||||||
| Total Amount Invested = Rs 6,714 | Total Amount Invested = Rs 11,000 | |||||||||||||
| Final Market Value = Rs 9,533 @ NAV of Rs 13 on Dec 1 | Final Market Value = Rs 13,670 @ NAV of Rs 13 on Dec 1 | |||||||||||||
| Net Average Cost Per Unit = Rs 9.15 | Net Average Cost Per Unit = Rs 10.46 | |||||||||||||
In the above example, VCA ensures a steady increase in the portfolio by Rs 1,000 every month irrespective of market conditions. VCA also mandates investing variable amounts i.e. investing more when the markets are down and less when the markets are up.
Since we have seen both the investment techniques, we will now look at the difference between VCA and RCA
- In case of RCA, the investment amount is fixed whereas in VCA the investment amount varies
- In case of VCA if the market value of the investments is more than the pre-determined target value then VCA also has a rule of redeeming units to book profits.
- Since VCA works based on market fluctuations, more units are bought when the market is down and less when the markets are up, hence the amount of investment in VCA is less when the markets are up as compared to RCA wherein the amount of investment is fixed. Also when the markets are down, the amount of investment is more as compared to RCA wherein again the amount of investment is fixed.
- The number of units in case of RCA may be more than the number of units in VCA, however the percentage return in VCA turns out to be more than in RCA.
- The cost per unit in VCA will be less than that in RCA.
| Rising Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Value Cost Averaging | Rupee Cost Averaging | |||||||||
| Month | NAV (Rs) | Target Market Value | Market Value Of Investment Before Investment | Amount Invested (Rs) | Units Purchased | Cumulative Units | Amount Invested (Rs) | Units Purchased | Cumulative Units | |
| 1 | 10 | 1,000 | 1,000 | 100.00 | 100.00 | 1,000 | 100.00 | 100.00 | ||
| 2 | 16 | 2,000 | 1,600 | 400 | 25.00 | 125.00 | 1,000 | 62.50 | 162.50 | |
| 3 | 20 | 3,000 | 2,500 | 500.00 | 25.00 | 150.00 | 1,000 | 50.00 | 212.50 | |
| 4 | 20 | 4,000 | 3,000 | 1,000 | 50.00 | 200.00 | 1,000 | 50.00 | 262.50 | |
| 5 | 32 | 5,000 | 6,400 | (1,400) | (43.75) | 156.25 | 1,000 | 31.25 | 293.75 | |
| Avg. NAV | 19.60 | 1,500 | 5,000 | |||||||
| Avg. cost per unit (Rs) 9.60 | Avg. cost per unit (Rs) 17.20 | |||||||||
| Falling Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Value Cost Averaging | Rupee Cost Averaging | |||||||||
| Month | NAV (Rs) | Target Market Value | Market Value Of Investment Before Investment | Amount Invested (Rs) | Units Purchased | Cumulative Units | Amount Invested (Rs) | Units Purchased | Cumulative Units | |
| 1 | 32 | 1,000 | 1,000 | 31.25 | 31.25 | 1,000 | 31.25 | 31.25 | ||
| 2 | 20 | 2,000 | 625 | 1,375 | 68.75 | 100.00 | 1,000 | 50.00 | 81.25 | |
| 3 | 16 | 3,000 | 1,600 | 1,400 | 87.50 | 187.50 | 1,000 | 62.50 | 143.75 | |
| 4 | 16 | 4,000 | 3,000 | 1,000 | 62.50 | 250.00 | 1,000 | 62.50 | 206.25 | |
| 5 | 10 | 5,000 | 2,500 | 2,500 | 250.00 | 500.00 | 1,000 | 100.00 | 306.25 | |
| Avg. NAV | 18.80 | 7,275 | 5,000 | |||||||
| Avg. cost per unit (Rs) 14.55 | Avg. cost per unit (Rs) 16.33 | |||||||||
| Sideway Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Value Cost Averaging | Rupee Cost Averaging | |||||||||
| Month | NAV (Rs) | Target Market Value | Market Value Of Investment Before Investment | Amount Invested (Rs) | Units Purchased | Cumulative Units | Amount Invested (Rs) | Units Purchased | Cumulative Units | |
| 1 | 20 | 1,000 | 1,000 | 50.00 | 50.00 | 1,000 | 50.00 | 50.00 | ||
| 2 | 16 | 2,000 | 800 | 1,200 | 75.00 | 125.00 | 1,000 | 62.50 | 112.50 | |
| 3 | 10 | 3,000 | 1,250 | 1,750 | 175.00 | 300.00 | 1,000 | 100.00 | 212.50 | |
| 4 | 16 | 4,000 | 4,800 | (800) | (50.00) | 250.00 | 1,000 | 62.50 | 275.00 | |
| 5 | 20 | 5,000 | 5,000 | 0 | 0.00 | 250.00 | 1,000 | 50.00 | 325.00 | |
| Avg. NAV | 16.40 | 3,150 | 5,000 | |||||||
| Avg. cost per unit (Rs) 12.60 | Avg. cost per unit (Rs) 15.38 | |||||||||
As I write this post, HDFC has introduced an option, HDFC Swing STP which works on the VCA principal. I have covered HDFC Swing STP in my Blog - http://swingstp.blogspot.in/
