Investment dilemma: Should you go for VIP or SIP.

Value-averaging investment plan helps investors to follow ‘buy low and sell high’ and achieve their financial goal in a pre-determined time frame.

The age-old wisdom of "buying low and selling high" is the only way you make money in the equity market. But for various reasons, be it behavioural and otherwise, fail to follow. However, there is a concept called Value Averaging Investment Plan (VIP) that utilizes the same concept to make money for you.       

What is a Value Averaging Investment Plan (VIP)

Investment in VIP is very much like the much-publicized SIP where you invest every month in a chosen mutual fund at a pre-determined frequency. However, the amount you invest is not constant and keeps on changing in VIP according to the market performance. Under VIP you set a target value of your portfolio that you want to achieve at the end of a period. Now you work backwards to achieve that target investment value every month.

Example

If as an investor you want to buy a car 12 months from now, that is valued at Rs 600000. Working backwards, you need to save and invest at least Rs 50,000 per month over the year in your mutual fund portfolio (For simplicity we are assuming no returns). In the first month, you invested Rs 50,000. In the second month, your fund performed better and now your fund value increased to Rs 51,000. Now in the second month, you need to invest only Rs 49,0000 as this will add up to Rs 1,00,000. In the third month, however, the market nosedived, and the investment value declined to Rs 98,000. Now to make up his portfolio value to Rs 1,50,000, the investor needs to invest Rs 52,000.

The above example clearly shows that when the market is high, VIP makes us invest less, while it forces us to invest more when the market is low, helping us to follow the classical strategy of “buy low and sell high”. One drawback of this strategy is you do not know beforehand what is amount you need to invest every month. Hence, you need to have extra liquidity to cover up any shortfall. Another disadvantage of VIP is that you may not invest during the bull run. This is the case in the current scenario where in the last one year Nifty 50 has increased by 53% or around 4% every month. So, depending upon your requirement, every month you will continue to contribute less towards your goal.

Nonetheless, VIP is mostly used by investors to achieve a target value for some specific purpose, like a car in the above example.