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Monday, September 20, 2010

VIP - Value Averaging Investment Plan

For most disciplined investors systematic investment plan (SIP) now forms the best way to put their money in equities. An investor keeps putting in a fixed sum at regular intervals, and in turn, he benefits from cost averaging without worrying about stock market fluctuations.

Investors prefer SIP as no one can time the market. Therefore, it also saves them from speculating the market rise and fall in the future. However, wouldn’t it be nice if we could invest more when the market is low and less when markets have risen?

Value averaging investment plan, or VIP, is the answer. This method of investing goes a step further from SIP.

The Difference:

In the backdrop of being more active than an SIP, VIP endeavours to provide better returns. SIPs average out your cost by buying a fixed amount at regular intervals. VIP invests more money in the chosen funds, the market slumps or the net asset value (NAV) of the fund drops. And, invests lesser amount when the markets rise.

This means, you don’t put a constant amount each month. Rather, the fund house will only take the amount depending on the movement of the equities.

The fund house takes this call based on multiple statistical, mathematical trend patterns fed into a computer, which identifies whether it is a bull or bear pattern and makes the decision on the amount that the investor needs to put at a given time.

VIP is a goal-oriented product. The investor needs to specify the corpus that he needs. The intermediate investments are done to achieve this defined corpus.

VIP would underperform an SIP when markets are rising, as there is lower sum invested when markets are inching up. In SIP, a fixed amount would keep getting invested. However, over a market cycle, VIP would outperform SIP since a person consistently deploys higher funds at every dip.

This is apparent if you compare the performance for someone who started an SIP and a VIP in January 2006, when the market was at 9,919 levels and then revived around October 2009 when market touched 15,896-level.

(See table: SIP vs VIP)

Operation: The mechanism of VIP is more complicated when compared to an SIP.

An example should make this clear: say, a person states that he wants to invest so that the monthly investment amount is Rs 1,000. So, he starts VIP with Rs 1,000 in the first month. In the second month, say, the fund value falls to Rs 900 due to market slump. In this case, the investor would contribute Rs 1,100. This will ensure that you meet the target corpus at the end of the tenure.

Over the next month, if markets rise and the fund value move to Rs 2,000, then the next contribution would scale down to Rs 800 only.

For simplicity, we assumed the investment based on the deficit between the market value and the amount invested. In practice, the VIP assumes a specified return on investments. In VIP, you adjust or vary the amount invested to meet a prescribed target value of the portfolio.

Using this mechanism, a person can build his financial goal and be sure of attaining it, irrespective of returns from the market. If you want your portfolio to grow by 15 per cent year-on-year, you contribute in such a manner as to reach this percentage each month.

Existing Schemes:

Among some of popular fund houses, which provide the VIP mode of investments is Benchmark Asset Management Company. It was is the first company to launch VIP in the country for an exchange-traded fund that tracks the S&P CNX 500. The product assumes 15 per cent returns each year and the minimum investment amount must be Rs 2,000.

Reliance has launched a similar initiative called Smart Steps. Under the scheme, investors deposit money in select Reliance debt funds and variable amounts are transferred to various equity schemes based on a logical model to maximise returns. HDFC flex STP is another plan that works towards varying the deployment as per market trends.

Those who have SIP and understand the nuances of stock markets, should look at VIP. Varying the amount of investment with market movement can help investors who want to use the volatility optimally.

An investor needs to be ready for varying amounts being deducted from the bank account at regular intervals. However, you can overcome this by investing a lumpsum in a fund house’s debt schemes and asking for a transfer in the chosen scheme.