What is Value Averaging
A similar investment strategy to SIP is Value Averaging strategy. In Systematic Investment Plan (SIP) one needs to make a set monthly investment of a certain amount which makes them buy more shares when the market is bearish and less number of shares when the market is bullish. In Value Averaging too, one has to have an amount every month but the amount is not fixed.
In the Value Averaging investment plan, an investor finds a fundamentally strong stock/index fund,etc and sets a target growth rate or a target amount and keeps investing in it on a regular basis. The amount is modified according to the relative gain or loss in the asset that the investor has chosen to invest in. Investors invest more when the asset’s price has decreased and invest less when the asset’s price has increased.
Value Averaging Example
Let’s take a hypothetical example to understand it better. An investor has decided to invest in XYZ stock and build wealth by investing in it for a long period of time. He has 1200 Rupees to invest this year. Now instead of investing 100 Rupees every single month, he waits for a downfall in the stock and then starts investing heavily.
The reason why Value Averaging works
The reason why Value Averaging works is, one starts reducing the average bought price of the asset. So for example, An investor bought a share at 100 Rupees. A few days later, the stock goes down to 90 and the same investor buys 1 share again. Now whenever the stock starts trading above 95 (the average price) he will be in a profitable position. According to theories, doing this over a long period of time gives unimaginable returns.
Advantage of Value Averaging strategy
The reason why most people fail in financial markets is that they take decisions on the basis of their emotions and that’s totally understandable as it’s their hard earned money. A Value Averaging investment plan helps to avoid this bottle-neck pretty accurately. By using this strategy, one can avoid fear and greed factors while making decisions and build financial discipline.
How is Value Averaging different from Dollar-Cost Averaging
Dollar-Cost Averaging refers to a Systematic Investment Plan where one is supposed to invest a fixed amount of money every month. Whereas when we talk about Value Averaging, the amount varies according to the movement of stock or any asset in the near past.
Value Averaging helps an investor to avoid the stock when they are hot and super bullish, ultimately not overpaying for the stock. In the long term, a person who avoids overpaying for stocks will get better returns than someone who overpays for it.
Additionally, Value Averaging works best in volatile markets. In a fierce bull market, investments may severely drop while investments would sharply increase in a trending bearish market.
Challenges in Value Averaging
The biggest challenge in Value averaging is management of money in trending markets. For example, one might run out of funds to invest when there is a shortfall in markets and might have surplus funds in a raging bull market. Both of them affect financial discipline.
Now that you have understood how to average down your stock price, it’s time to open demat account with Angel One and start building wealth.