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Are your investments earning you enough?

While the rather well known SIPs (systematic investment plans) gave an investor the benefit of rupee-cost averaging, the new kid on the block VIP (value averaging investment plan) claims to go one step ahead. This is another example of the continuous innovation in the investment world, with the basic objective of enhanced returns.

VIP vs. SIP

The VIP is a new entrant in the market and promises to be more 'active' than a SIP; it also endeavours to provide better returns.

Systematic plans average out your cost by buying a stipulated amount at regular intervals (monthly / weekly) by buying more units when the market slumps and lesser units when the markets are high. However, the amount for which the units are bought does not change.

The VIP uses a slightly different strategy; it varies the amount being ploughed into the fund. If the markets are lying low, it proposes to invest a higher amount (thereby buying more number of units) and when the markets are at peak, it proposes to invest a lower amount (lower number of units are bought).

Investors are familiar with the concept of rupee-cost averaging or SIP of a mutual fund, where one invests a fixed sum at fixed regular intervals.

VIP is a more evolved concept than rupee-cost averaging. Here the investor is expected to adjust the amount to be invested in tandem with the direction of the market -- up or down -- to achieve prescribed value of the fund or targeted returns.

Mechanics of value average investing

Under the VIP you start-off investment with a nominal amount; let us presume that an investor starts this investment initiative with Rs 1,000 in the first month under VIP. For the sake of simplicity, we will not assume any percentage returns.

Now let's say in the second month, the value of the fund falls to Rs 900 due to a market slump. In such a case one would contribute Rs 1,100 to make it equivalent to Rs 2,000, which is the target value of the fund.

Over the next month, if the market moves up to Rs 2,200, then the contribution will be scaled down to Rs 800. This will ensure that the fund value is at the stipulated Rs 3,000 at the end of the third month.

While for simplicity, we assumed the investment each month to be based on the deficit between the market value and the amount invested, in reality, VIP normally assumes a particular return. The extent of the investment would depend on the difference between the market value and the value of the investment at a projected rate of return.

In this way of value averaging, the risk is often minimised and the returns can be starkly higher than the usual systematic investment plan.

Value averaging is a great way for investors to diligently increase the value of their investments as market falls. In fact, the real benefit of this plan would come to light only when your investments have passed a bear cycle and moves into the bull zone. 

Options available

In India, the Benchmark Mutual Fund offers a VIP. The investors are allowed to choose a nominal amount with which one can start the investment. The fund also allows you to cap the maximum debit from the account to specifically ensure that the investor's cash flow is not adversely impacted.

For someone who has capped his maximum debit at Rs 15,000, the actual debit can be between Rs 0 to Rs 15,000. The rate of return assumed by the fund is stipulated at 15 per cent. For example: if an investor is investing a nominal amount of Rs 5,000 per month for a given period. Let us assume that for the installments put in, the value of the investment assuming a 15 per cent annualised return should have been Rs 2.25 lakh.

If on the other hand, the market value remains only Rs 2.15 lakh, in the next month, the deficit of Rs 10,000 would be additionally debited from the account over and above the nominal debit of Rs 5,000 (that is, totally Rs 15,000 would have been debited for the month).

Our take...

For investors looking for a more cerebral way of investing compared to SIPs that contribute a fixed amount every month, the value investment plan is an option worth considering. Given that 'timing the market' has been an oft-chased myth and identifying trough and peaks can be an almost impossible task, varying the amount of investment with time can help investors.