If you are a regular investor in Mutual Funds or equities, you always wished that you could invest more when the market were low and invest less when the markets are high. But it’s a known fact that timing the market is impossible. So the next best thing for an investor is to invest regularly the SIP (Systematic Investment Plan) or Rupee (Dollar) cost averaging way. But is there something or some other way we can outperform the SIP or overcome some of its disadvantages?
I think I have an answer – invest the VIP (value Averaging Investment Plan) way.
What Does Value Averaging Mean?
It’s an investing strategy that works like SIP in terms of steady monthly contributions, but differs in its approach to the amount of each monthly contribution. In value averaging, the investor sets a target growth rate or amount on his or her asset base or portfolio each month, and then adjusts the next month’s contribution according to the relative gain or shortfall made on the original asset base.
Does it sounds too alien; let me explain it by an example.
Suppose you want Rs 1,000 added to your equity mutual fund every month and you start with investing Rs 1,000. Now at the end of first month the value of your fund becomes Rs 1100. So now you need to invest only Rs 900 (1000-100) to make the investment worth Rs 2000. In the following month the value of investment reduces to Rs 1800 due to correction in the market, so you need to invest Rs 1200 (3000 – 1200) to make the amount to target amount of Rs 3000.
So what happens that you invest more when the prices fall and invest less when they rise. Like in the first month when the market rose you bought units with Rs 900 only while when the market corrected next month you invested Rs 1200. In other words, you buy more (units) when the prices are low and you end up investing less (buying less units) when the markets peak.
Value Averaging – Advantages
- It invests more rupee amount when markets are lower and less when markets are higher.
- As a discipline, it helps investor overcome emotions.
- In most cases it generates higher returns than normal SIP which is based on rupee cost averaging technique.
- It achieves lower cost of acquisition in most scenarios as compared to SIP.
- The probability of achieving target value for a portfolio is much higher and hence ideal for financial planning.
- Longer the investor horizon, higher the benefits.
Value Averaging – Challenges
The key disadvantage of the VIP is that the sum you invest each month will be highly unpredictable. A salaried individual whose income is constant may find it difficult to commit to a VIP knowing that the sums debited to his account may vary so widely. This may prompt him to commit to a low monthly investment. Therefore, investors who have the flexibility to overshoot their investment targets significantly can consider the VIP.
In long term and constantly falling markets the investment amount may increase much beyond the investor’s cash flow.
The second factor is that investing through a VIP is most effective when the market is not moving in one direction. If on starting the VIP the market is in a steady decline for many months, investors in a VIP would find themselves committing larger and larger sums to the equity fund, even while the investment loses value. Such a course may be difficult to stick to, as the absolute loss to the investor can be very high.
The third factor is in rising market it generates sell which may result in unwarranted short term taxation and transaction charges
Who offers the VIP?
Benchmark mutual fund is the only AMC offering VIP in S&P 500 Fund. Also there is FundsIndia where you can do VIP in different funds.
Data suggests that the VIP delivers a higher return on an average as compared to a SIP. For investors looking for a more intelligent way of investing compared to the SIP that contributes a fixed amount every month, the VIP is an option worth considering.