In my previous article, I wrote on Dollar Cost Averaging (DCA). Personally, I’m in favour of DCA where it views investing as an activity to build progressive wealth for the long-term. With that being said, I’m not a fan of investing into a stock or any investment vehicles when the price is overvalued. Therefore, I would adopt a better investment approach known as Value Cost Averaging (VCA).
What is Value Cost Averaging (VCA)?
It is a combination of DCA and value investing.
DCA advocates investors to fix an amount to invest on a periodic basis. It can be on a monthly, quarterly, half-yearly or yearly basis. Value investing is an activity of accumulation of shares of great businesses when their prices are reasonably low or undervalued. Therefore, unlike conventional DCA, VCA would discourage investors to invest when the investment is overpriced.
Who Should Use VCA to Build Stock Portfolios?
It is suitable for investors who have limited capital, stable cash flow, and plan to build wealth slowly, systematically, and sustainably via stock investing. It is ideal for working adults, especially fresh graduates for they have a longer time frame to compound their wealth as the businesses invested continue to expand in the long-run. VCA may not work under the following circumstances:
a. The person is not financially fit to invest.
b. The person is about to make a huge financial commitment in 1-2 years time.
c. The person wishes to make a quick buck via speculating or trading stocks.
How does VCA work?
In this article, I’ll share four steps to build your portfolio by using VCA:
Step 1: Set Your Investment Criteria
Let us revisit what value investing is. It involves accumulation of shares of great businesses at good prices. Today, there are 900+ stocks listed on Bursa Malaysia and 700+ stocks listed on SGX. I’m sure not every single stock listed would be of good investment, thus, needing us to identify good ones from the bad ones. As such, the questions you may ask are as follows:
a. How do you tell a good stock from a bad one?
b. What are the key characteristics you find in good stocks?
Often, this would require investors to study the business models, management, financial results and future plans of a stock to determine its quality. Fortunately for us, these information are available in a stock’s Annual and Quarterly reports for free. Let’s say, you have identified a pool of good stocks. I’m also pretty sure that some of these good stocks are cheap and some are expensive. Hence, here is our next question: ‘How do you know if a good stock is cheap or expensive?’
In essence, you should have the following list before investing:
Here is a personal note:
If you find it difficult to answer the above questions, it is okay. It means, you’re not ready to invest in the stock market. The best investment I believe you could make is to buy a book on value investing and start learning. You can come back into the game once you are more learned with a game plan in hand.
Step 2: Build a Watch List of Good Stocks
Next, build a simple watch list consisting of 20-30 stocks based on your criterias set above. You should have the following:
Step 3: How Much Can You Afford to Invest?
I have worked out a calculation in my previous article – Dollar Cost Averaging.
From it, I calculated that if you have RM 12,000 in initial capital, you can choose to split your capital into RM 1,000 per month to be invested over 12 months. In addition, if you can save RM 1,000 a month from your income, then, you would be able to invest up to RM 2,000 per month to build your stock portfolio.
Step 4: Buy Only if the Investment Makes Sense
Let’s say, you have RM 12,000 in initial capital, can save RM 1,000 a month, and have built a watch list of your 20-30 preferred stocks. Awesome! Now, let us go shopping for stocks.
Month 1 – January 202x:
In month 1, you found TYE Bhd to be a good stock to invest for it offers the best deal from your watch list of 20-30 stocks. Thus, you invested RM 2,000 into TYE Bhd. Your cash position and stock portfolio would be as follows:
Month 2 – February 202x:
In month 2, you found NKC Bhd to be a good stock to invest for it offers the best deal from your watch list of 20-30 stocks. Thus, you invested RM 2,000 into NKC Bhd. Your cash position and stock portfolio would be as follows:
Month 3 – March 202x:
In month 3, you found none of the stocks in the watch list offers a good deal. In this case, you just park the RM 1,000 in monthly savings into your ‘initial capital account’ shown as follows:
In short, I believe VCA offers investors a more practical approach to investing as it considers both the quality and valuation of an investment. This would enable investors to make regular investments only if they make sense, thus, avoiding a series of investments made into bad investments at the wrong time. So, is VCA a viable strategy for you to build long-term wealth via stock investing? Please comment below: