Variable Ratio Plan

Variable Ratio Plan

According to this plan, at varying levels of market price, the proportions of the stocks and bonds change. Whenever the price of the stock increases, the stocks are sold and new ratio is adopted by increasing the proportion of defensive or conservative portfolio. To adopt this plan, the investor is required to estimate a long term trend in the price of the stocks. Forecasting is very essential to this plan. When there is a wide fluctuation variable ratio plan is useful. The table explains the variable ratio plan.

In the above example, the portfolio is adjusted for every 20 per cent change in the stock price. This adjustment criterion may be different for different investors depending upon their attitude towards risk and return. The portfolio is divided into two equal portions as in the case of other plans, with R,10,000 in each. Let us assume that there is a fall in the price of the stock, then, the percentage of stock in the portfolio declines. As the market price for the stock reaches a 20 per cent decline, that is to Rs,80, the adjustment action takes place. The purchase of 58 shares raises the stock portion to 72.48 per cent. Once again, when there is a 20 per cent change, the adjustment action is triggered. When the prices have increased to ` 100, the investor sells 50 shares and the stock portion in the portfolio is reduced back to 50 per cent.

The figure explains the variable ratio plan. The middle line is the trend line that represents the investor’s expectation about of future course of prices. Zone 1 and 3 represent respectively of 10 and 20 per cent deviations above the expected trend, and zones 2 and 4 represent respectively 10 and 20 per cent deviations below the expected trend. Starting at ` 50, the portfolio’s bonds and stocks ratio is 50:50.

At point A, the portfolio is adjusted to the next proportion, in this case 60 per cent bonds and 40 per cent stocks. At B, again it is 50:50. Below point C there would be more stocks than bonds. Because of the decline in stock price, more stocks are purchased. Above the point D, it is again 50:50. The line moves closer to the trend line

Advantages

Automatically, the investor tends to correct his portfolio portions according to the price changes. The investor is not emotionally affected by the price changes in the market. With accurate forecast the variable ratio plan takes greater advantage of price fluctuations than the constant ratio plan.

Limitations

The investor has to construct the appropriate zones and trend for alterations of the proportions

The selection of security has to be done by the investor by analysing the merits of the stock. The plan does not help in the selection of scrips.

If the zones are too small frequent changes have to be done and it would limit portfolio performance.