Buy low, sell high -- that is what conventional wisdom tells us. For common investors, it may not be always possible to determine when stock prices are exaggerated and when they are not.
Especially, with Sensex crossing 7000, investors are concerned. How long with this rally last? Are stocks overpriced or underpriced? And many more questions.
But irrespective of where stocks head, you can maximise returns (or minimise losses) by using some simple strategies.
One way to do this is called value averaging. It is slightly different from the conventional rupee-cost averaging.
Rupee-cost averaging, popularly called systematic investments plan, is a strategy in which you invest a fixed rupee amount on a regular basis, usually monthly purchase of shares or units of mutual funds.
When the share/fund's price falls, you receive slightly more shares for the fixed investment amount, and slightly fewer when the price is up.
How does it help? This strategy helps in lowering the average cost, in a market where the share price/net asset value of the fund fluctuates up and down.
Value averaging is a more evolved strategy. In this, you adjust or vary the amount invested, up or down, to meet a prescribed target value of the portfolio.
An example should make this clear: Suppose you plan to invest Rs 1,000 per month in a mutual fund (actually, you pre-fix the amount you would like to have in your investment portfolio at the end of every month), and at the end of the first month, thanks to a decline in the value of your fund, your Rs 1,000 has shrunk to Rs 900. Then you add in Rs 1,100 the next month, bringing the value to Rs 2,000 (2 x Rs 1,000).
Similarly, if the fund is worth Rs 2,300 at the end of the second month, you only put in Rs 700 to bring it up to the Rs 3,000 target.
Why is this better? Compared with rupee cost averaging, you put in more when prices are down, and less when prices are up. In fact, you sell stocks/units when prices are up. Value averaging also involves a bit of profit booking when markets are on a rampage.
Since stock prices keep fluctuating, it is always a good idea to invest gradually.
According to Parag Parikh, chairman, Parag Parikh Financial, most individual investors have missed the Sensex rally from 3000-6000 and they are entering the market seeing the relentless rise in stock prices. Getting tempted by the recent surge in stocks prices and committing all the money is a big risk common investors can't afford.
The better option is to invest periodically. This reduces risk as you buy stocks at a variety of prices throughout the year instead of buying all your units at a single price.
Needless to say, if the market continues to rise without any look back, an averaging strategy can yield lower returns.
But the Sensex being where it is, the challenge for most investors really is capital preservation with modest gains.
How to work it out