There are three basic formula plans namely, constant rupee value plan, constant ratio plan and variable ratio plans. They are briefly explained as follows.
1. Constant Rupee value plan
Explanation of Rupee Value Plan
The constant rupee value plan indicates that the rupee value remains constant. in the stock portfolio of the total portfolio. Whenever the stock value rises the shares of the investor should be sold to maintain a constant portfolio. Likewise, the investor should buy shares whenever prices fall in order to maintain a constant portfolio.
The investor invests a part of his funds in the aggressive portfolio and a portion of his total funds should be invested in a conservative portfolio.
This plan provides action points which are also known as revaluation points. The action points enable the investor to maintain the constant rupee value by effecting transfers from aggressive to conservative portfolio and vice versa. The action points work by giving some specifications to the investor. The action points specify a certain range of fluctuations of stock prices, say, for example 25%.
If the fluctuations are within 25% range, the investor should not make any transfer from conservative portfolio to the aggressive portfolio. Only when fluctuations in prices cross this range, the investor will have to plan transfer between his portfolios.
Advantages of Constant Rupee Value Plan
The constant rupee value plan offers the following advantages.
1. It is very simple to operate. The investor need not make any complicated calculations.
2. This plan brings funds to the investor for investment.
3. Constant rupee value plan specifies the percentage of the aggressive portfolio for the investment fund. Specified as a percentage to the total fund, the aggressive portfolio will have a constant amount.
2. Constant ratio plan
Explanation of Constant Ratio Plan
There is a slight difference between the constant rupee value plan and the constant ratio plan. Constant ratio plan specifies the ratio of the value in the aggressive portfolio to the value of the conservative portfolio. The aggressive portfolio is divided by the market value of the total portfolio and the resultant ratio will be held constant. This can be expressed as a formula.
K = Market value of common stock / Market value of total portfolio
How do constant ratio plan work?
Constant ratio plan works as follows:
1. When the value of stock rises, it must be sold to make it constant with the value of the conservative portfolio. When the value of stock falls, the investor should transfer funds to common stock.
2. The investor should keep the aggressive value constant of the portfolio’s total value. When the prices of stock fall, the investor should transfer from conservative to aggressive value.
3. The investor need not forecast the lower levels at which the prices fluctuate.
4. The core of constant ratio plan lies in the purchase of stock in less aggressive manner as the prices fall.
5. When the stock prices rise, sale of stock is effected in less aggressive manner.
6. The sales and purchase of aggressive stock depend upon the middle range of fluctuations. If the fluctuations in prices are just above the middle range of sales, it is regarded as the most aggressive point. Likewise, if the fluctuations are just below the middle range, it is identified as the least aggressive.
7. When the stock prices fluctuate above the middle range of fluctuations, shares are sold aggressively. Similarly, when the stock prices fluctuate below the middle range of fluctuations, shares are bought aggressively.
8. When there is a continuous and sustained rise or fall in share prices, the investor will make enormous profit.
3. Variable ratio plans
The variable ratio plans can be understood by studying the following points.
1. When stock prices rise, the investor should sell stock and purchase. bonds. Similarly, when the stock prices fall, stock should be bought and bonds should be sold.
2. There should be different proportions of stock prices.
3. Forecasting is the most important technique of variable ratio plan.
4. This plan is found to be profitable when there are large number of fluctuations in prices.
5. The variable ratio plan works with indicators like market index, the economic activity index, etc. So, the ratios are to be varied whenever economic index or market index changes.