Want your mutual fund investment to make more money?

Buy low, sell high -- that's what every investor in the world wants to do.

Many investors have been told that systematic investment plans are an ideal way to do this -- this is one method by which they can average their cost without trying to time the market and make a lot of money.

You time the market when you try to buy a stock at its lowest price and sell when it is just about to reach its peak. Even the most seasoned stock market players will tell you that this is a near impossible task.

But what if there is a method that can give you superior returns than a SIP even as it takes a similar risk?

This is where value cost aaveraging comes into picture.

What is VCA?

Value cost averaging is a strategy of spending more money to buy mutual fund units when the price is low and less money when the price is high. It is similar to SIP, though it can be more effective. It also requires a more active role from the investor as compared to a SIP.

However, there is a difference between the two. In VCA, you keep on increasing your investment amount as the value of a mutual fund unit reduces and vice versa.

SIPs allow you to invest a fixed amount at a fixed interval (every month). This means you invest the same amount even when the value of a MF unit comes down.

SIP is a safe investment strategy; any financial expert or experienced investor can tell you that. But the problem for this type of investment strategy is that you are sacrificing maximum profit potential in exchange for simplicity, automation and less of an active role by you as an investor. VCA, on the other hand, allows you a more active role.

• Is the super SIP a great investment?

In order to make the VCA system work, the first thing you should do is NOT to second-guess (time) the market. You must be able to invest on a regular basis without fail.

Here is how value cost averaging investing works

Take note of the date and the price you paid per unit of a mutual fund scheme. Let us assume you invested Rs 1,000 at Rs 10 per unit. When it is time for the next investment you check the net asset value, NAV, of the fund on this site or on the monthly fund statement that you can get.

SIP vs VCA

SIP: When you invest using the SIP strategy, you invest a fixed sum every month.The example mentioned below shows that no matter what the NAV, the person would put in the fixed sum of Rs 1,000 every month. With that s/he tries to achieve an average price which would be lower than the price s/he would have paid if s/he would have made a lump sum purchase on day one.

VCA: As shown in the example above, the first thing you need to determine is that how much money do you want to invest in mutual funds at the end of each period.

Say, in this case, you want a total investment of Rs 6,000 at the end of six months in a mutual fund in such a manner that, at the end of first month, your total investment is Rs 1,000, at the end of second month your total investment is Rs 2,000 (including the Rs 1,000 invested in the previous month and so on).

Then you can break up this Rs 6,000 over the 6-month period. Unlike a SIP, which entails putting in Rs 1,000 (or for that matter any fixed amount) every month, the amount invested using VCA technique will vary every month. However, the target of investing Rs 2,000 by the end of second month, Rs 3,000 by the end of third month remains unchanged.

Say, in the first monthof your VCA investment, the cost per unit of the mutual fund that you want to buy is Rs 10 and you are putting in Rs 1,000. This will get you 100 units (Rs 1,000/ Rs 10).

Now, assume that the markets did well and the cost per unit increased to Rs 10.50 by the end of your second month. At this time, the value of your investment would have become Rs 1,050 (Rs 10.5 * 100). Now, remember, the total money you need to invest by the end of second month is Rs 2,000. So, you need not put in another Rs 1,000 this month. Your total investment this month will be Rs 950 (your target investment - the value of your investment; ie Rs 2,000 - Rs Rs 1,050).

With this Rs 950, you can buy 90.48 units (Rs 950 / Rs 10.50) that will take your total units at the end of second month to 190.48 (100 units in the first month plus another 90.48 units in the second month).

• Why an SIP is not always great

In the third month, let's say the cost per unit of your mutual fund further increases to Rs 13. This will take the value of your investment to Rs 2476.24 (190.48 * Rs 13). So, the amount you need to invest in the third month will be Rs 3,000 (your target as decided in the beginning) less Rs 2476.24, that is Rs 523.76.

With this amount at the end of the third month, you will be able to buy 40.28 units (Rs 523.76 / Rs 13). The total number of units at the end of the third month at 230.76 (190.48 plus 40.28).

Now, let's see what happens when the cost per unit goes down. As per the table in the fourth month, the cost of each unit has gone down to Rs 8. That takes the value of your investment to Rs 1,846 (Rs 8 * 230.76). That means at the end of the fourth month you will have to invest Rs 2153.92 (Rs 4,000 less Rs 1846).

This clearly shows that, in the VCA method, you keep increasing your investment amount as the value of a mutual fund unit reduces, and vice versa. This is how it goes on and on till you deem it fit to stop your VCA investment. In the example above, we have stopped at the end of the sixth month.

This is the basis on which the VCA method works.

The table above shows the effect at the end of the sixth month. The total amount invested in SIPs is Rs 6,000 (Rs 1,000 every month) and you get 605.27 units at a price of Rs 9.91 ( Rs 6,000 / 605.27) per unit.

But the total amount invested using the VCA strategy is Rs 5,597 and you get 600 units at an average price of Rs 9.32 (Rs 5,597 / 600) per unit.

• Investing in micro-SIPs? Read this

Current value for SIP = Rs 10 (the price at the end of the sixth month) * 605.27 (total units) = Rs 6,052.70

Current value for VCA = Rs 10 (the price at the end of the sixth month) * 600 (total units) = Rs 6,000

At the end of the sixth month, the cost of one unit is Rs 10. That will take the value of your SIP investment to Rs 6052.70 (Rs 10 * 605.27) against an investment of Rs 6,000 and the value of your VCA investments to Rs 6,000 against an investment of Rs 5,597.

So, the profits made by you investing in SIPs is Rs 52.70 (Rs 6,052.70 – Rs 6,000) and the profits made under the VCA method is Rs 403 (Rs 6,000 – Rs 5,597).

Profits in per cent made under SIP = (Rs 52.70 / Rs 6,000) * 100 = 0.88 per cent and

Profits in per cent made under SIP = ((Rs 403 / Rs 5,597) * 100 = 7.20 per cent

This makes it abundantly clear that your profits have increased at a faster pace via VCA method (7.20 per cent), against a mere 0.88 per cent via the SIP method.

As you can see, the majority of shares are purchased at low prices. When prices drop and you put more money in, you end up with more units (this happens with SIP as well, but to a lesser extent). Most of the units have been bought at very low prices, thus maximising your returns when the time to sell beckons.

If your investment is in a sound scheme, VCA will increase your returns beyond simple SIPs for the same time period. And it does so at a lower level of risk.

Warning: Neither approach will bail you out of a declining market with all your money intact.

All said and done remember this gem from multi-billionaire investor Warren Buffet: The best holding period is forever.