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VIP: A plan that offers safety plus reasonable returns

Value averaging investment plan (VIP) is a powerful investment concept which provides considerable safety from the market volatility, discipline and reasonable guarantee of returns.

It is a common practice for equity investors to invest more when markets fall and restrict investment when markets rise. But many disciplined investors find it difficult to time the market and therefore invest in options such as systematic investment plan (SIP) to reduce market risks.

An SIP, however, invests the same amount irrespective of market movement. Value averaging investment plan adds an additional aspect of timing the market to regular investing.

It lets investors take advantage of the highs and lows of the market thus allowing for better returns.

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What is value averaging investment plan (VIP)?

In a value averaging investment plan, the amount invested each month is not fixed, but varies with the fluctuations of the market. Investors have a target portfolio value that they desire over a certain period of time.

With each passing month, the plan adjusts the next month's contribution as per the relative gain or fall of the portfolio value, from the target portfolio value. When the market declines, the investor contributes more and when the market goes up, the investor contributes less.

This way the anticipated return remains more or less constant for the investor.

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How does VIP work?

Let us take an example to understand the concept.

Consider investing Rs 1,000 in the markets every month. Supposing after the first month, the market is in a downward trend, and the portfolio value falls to Rs 800.

In such a case, the second instalment would not be Rs 1,000, but would be Rs 1200, that is, Rs 2000 minus Rs 800.

After the third month, suppose the markets rise and the portfolio value now is Rs 2,400, then Rs 600 (Rs 3,000 minus Rs 2,400) will be invested.

The plan thus establishes the target portfolio value by periodically calculating the investment amount, and bridging the gap between the target value and the actual portfolio value.

Some fund houses also specify an expected rate of return they aim to deliver from their plan, say 12 per cent each year. The contributions are then varied in such a manner so as to reach this percentage each month.

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Who offers them? What are its advantages?

Benchmark AMC offers VIP through S&P CNX 500 fund. This fund assumes a return of 15 per cent each year.

Reliance offers a similar scheme called Smart Steps. In this case, investors need to invest money in select Reliance debt funds and variable amounts are transferred to various equity schemes based on a logical model to maximise returns.

HDFC offers flex STP that deploys varied amounts as per market trends.

Advantages

• Times the market with varying monthly contributions.
• Brings a disciplined, regular investment habit.
• Useful if you seek a certain amount of money over a certain period of time.
• Not only reduces risk, but also offers investors reliable returns.

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Comparison: Value averaging plan (VIP) vs systematic investment plan (SIP)

While an SIP follows the principle of rupee cost averaging, that is, investing a fixed amount at regular intervals, a VIP averages by investing varied amounts thereby allowing investors to utilise the ups and downs of the market.

The final returns in a SIP are not known and it depends on the market movement. In a VIP, investors define the final corpus required and investments are done accordingly.

VIP investments have the following disadvantages over a SIP. The amount invested each month could be highly unpredictable. If the markets are in a slump, or, if the market moves in only one direction, steadily declining for months, the investor may be investing larger and larger sums of money, thereby losing the investment value.

On an average, past performance data suggests that VIP has outperformed SIP. It works well in the long run in a highly volatile market with ups and downs. As an investor, go in for a value averaging plan, if you are looking long term, and have a comfortable cash flow to meet commitments when the markets dip.