Friday, April 20, 2012

Value Cost Averaging Strategy Explanation

A lot of you must have heard of Dollar Cost Averaging Strategy (DCA). It is widely promoted by the unit trust agents or banks in telling you the strategy to get your money invested in the Unit Trust / Stock Market.

The DCA strategy is basically a way to perform accumulation. The theory behind it is that since you have no time or you can't basically time the market on the high and low, you average your cost by investing a certain amount consistently. This is how it works:

Let's take a real life example.
Let's say we started to invest in Morgan Stanley Stocks a year ago.

For easy calculation then we will invest US1,000 in Morgan Stanley every two months. (this interval can be different depending on you).

May 2011 - Price: US26,03
US1,000/ US26.03 = 38 shares

Jul 2011 - Price: US23.76
US1,000/ US23.76 = 42 shares

Sep 2011 - Price: US16.93
US1,000/US16.93 = 59 shares

Nov 2011 - Price; US16.23
US1,000/US16.23 = 61 shares

Jan 2012 - Price: US16.08
US1,000/US16.08 = 62 shares

Mar 2012 - Price: US19.19
US1,000/US19.19 = 52 shares

So during the year, you've accumulated a total shares of 314 shares. Total cost is US6,000.
US6000/314 = US19.10 per share.

In this article. I'm going to teach you another method called Value Cost Averaging.
With the same example


May 2011 - Price: US26,03
US1,000/ US26.03 = 38 shares

Jul 2011 - Price: US23.76
38 * US23.76 = US902.90
Since you're planning to increase your total holding to US2,000.
US2,000 - US902.90 = US1097 (this is the amount to top up)
USD 1097/US23.76 = 46 shares

Sep 2011 - Price: US16.93
(38 shares + 46 shares) * US16.93 = US1422.12
Your holding suppose to be US3,000 - US1422.12 = US1577.88
You'll top up US1577.88 which is 1577.88/16.93 = 93 shares

Nov 2011 - Price; US16.23
(38 + 46 + 93) * US16.23 = US2872.71
Your holding now is suppose to be US4,000 - US2872.71 = US1127.29
US1127.29/ US16.23 = 69 shares

Jan 2012 - Price: US16.08
(38 + 46 + 93 + 69) * US16.08 = US3955.68
US5,000 - US3955.68 = US1044.32
US1044.32/US16.08 = 64 shares

Mar 2012 - Price: US19.19
(38 + 46 + 93 + 69 + 64) * 19.19 = US5948.90
US6,000 - 5948.90 = 51.1

US51.1/19.19 = 2 shares

Your total holding for a year is 38 + 46 + 93 + 69 + 64 + 2 = 312 shares.
Total Cost is US1,000 + US1097 + US1577.88 + US1127.29 + US1044.32 + US51.1 = US4853.27
Your average cost is US4853.27 / 312 = US15.55.




If you read through the calculation carefully. You find that during price is more expensive, VCA will purchase less stocks and when price is low VCA will purchase more stocks. This is different than DCA where it will purchase similar amount of shares throughout the period.

The end results will make your investment more worthwhile where you have lower cost for the shares US15.55 compare to US19.10 per share.

This strategy is good to adopt for stocks that has a bit of volatility (meaning goes up and down by season).
If you're investing in stocks that goes up all the way, then you'll be limited chances to accumulate such stocks.
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