SIP is good for investors who do not have the time or expertise to track their investment. However, V0IP requires active monitoring as well as recalculation of the investment amount every month
For There is no denying that Systematic Investment Plan (SIP) has become very popular among mutual fund investors of late. A SIP is regular investment in a mutual fund or a set of mutual funds every month or every period as desired. However, for the hands-on investor, there are other similar periodic investment options, such as the Value-averaging Investment Plan (VIP), that may provide better returns.
SIP versus VIP
A SIP takes advantage of what is known rupee cost averaging. Suppose you invest a regular amount of Rs 10,000 per month in a mutual fund scheme. If the mutual fund’s net asset value (NAV) or unit price goes up by 2% in a month, your investment grows. In the next month, you again buy mutual funds worth Rs 10,000. You can buy fewer units in the second month because of the rise in NAV but you earned profit on previous investment.
Similarly, when the NAV goes down by 2% in a month, your investment value may go down marginally but you can now buy more units with the same Rs 10,000 investment.
Regardless of the fluctuations, the monthly contribution remains constant. This accumulation of investment and returns over long-term balances out the fluctuation in mutual funds’ performance and delivers a better return at lower risk.
VIP also works on the rupee cost averaging principle, but in a slightly different way. The investing amount is benchmarked around a figure (like the SIP amount in case of a SIP). Since the figure is just a benchmark, the real investment every month varies slightly from it depending on the returns every month and the expected returns.
Suppose you start a VIP with a benchmark figure of Rs 10,000 per month. Your expected annual return is 12%, roughly translating to 1% per month discounting the minor impact of compounding.
In one month, your expected value of Rs 10,000 investment should be Rs 10,100. In reality, however, return is not consistent. Suppose, in a month, the NAV of mutual fund goes down by 2%. Hence, your investment value is Rs 9,800 after a month. You incur a deficit of Rs 300 when compared with your expected return.
Hence, in the second month, you would invest an additional Rs 300 to the benchmark figure of Rs 10,000, bringing your second month’s investment to Rs 10,300.
Now suppose, in the next month, the NAV goes up by 1%. Now, the expected value (had you invested Rs 10,000 every month through a SIP for the previous 2 months) is Rs 20,301, which is equivalent to two months of compounding on Rs10,000 at the rate of 1% per month and one month of compounding on Rs 10,000 at the same rate.
The actual value, however, is one month of compounding on Rs 20,301, which is Rs 20,504. Since the actual value of your investment, i.e., Rs 20,504 at the end of two months is more than the expected value of Rs 20,301, your investment will be less in the third month by a similar amount. Your investment in the third month will be Rs 10,000 – (Rs 20,504 – 20,301) = Rs 9,797. This goes on every month until the end of VIP.
SIP and VIP both use rupee cost averaging, but SIP is simpler and easier to administer. Once you give a mandate to the fund house to invest a certain amount every month, things are taken care of automatically.
Hence, SIP is good for investors who do not have the time or expertise to track their investment. VIP requires active monitoring as well as recalculation of the investment amount every month.
The writer is CEO, BankBazaar.com