Sunday, February 7, 2010

Value-averaging investment (VIP): Improved Systematic Investment Plan (SIP)


We all know Systematic Investment Plan has yielded higher returns. Almost all the mutual funds have SIP option. An improved version of SIP is Value Averaging Investment (VIP), which most of the international finance institutions are already following and yielded better returns than SIP.


In India, One mutual fund – Benchmark funds – has already implemented this method with one of their funds, with good results. In VIP the monthly amount of money invested varies based on the formula compared to SIP where the invested amount remains constant.

Strategy: The idea is to keep the value of the portfolio at an average value during the tenure of the investments. Money invested in periodic intervals in a portfolio varies in such a manner that the portfolio value keeps tending towards a pre-determined value based on a target rate of return. Since portfolio might grow or shrink from month to month, the targeted value for the portfolio might come nearer to or recede farther from the actual value, so the subsequent investment tries to compensate by investing less or more in the portfolio.

Example: Lets assume you have decided to invest Rs.5000 every month for next 1year. We shall fix a reasonable return rate as 15%. First month we pay Rs.5000 and assume the portfolio had 2% growth, so after one month, Rs.5000 will be Rs.5100. Our expected value after one-month, is (given the target return of 15 per cent), Rs. 5063 and out portfolio is already Rs.37 higher, so our investment second month is Rs.5000 - Rs.37 = Rs.4963.

Suppose if the portfolio had decreased 10%, our portfolio value after one month is Rs.4500, which is Rs.563 less than our target (15% target), so our second month investment will increase to Rs.5563 to achieve 15% target return.

Ultimately the logic is you end investing more in downward markets and invest less during upward market. Long run, assuming the equity markets generally trends upwards, this process holds the promise of better return over an equivalent SIP.

Happy Investing.

1 comments:

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