Investors can turn volatility into their favor by investing higher amounts when the market is falling and lower when the market is rising.
By Gautam Kumar
In a volatile market, most investors take the systematic investment plan (SIP) to invest fixed amount at equal intervals because of the rupee-cost averaging. If markets are down, it will fetch more units and less when markets are up, thus averaging the cost of units.
Other approach is value-averaging investment plan (VIP). The rationale behind this kind of investment is when markets are down, invest more money and less when market goes up. This approach is a derivative of ‘buying low and selling high’ philosophy so as to maximize your returns.
Now let us try to understand throughnumerical illustrationshow SIP and VIP work for retail investors.
SIP vs VIP
An investor does monthly SIP of Rs 5,000 in Sensex starting from January 1, 2014 for five years. During this journey, investor accumulated Rs 3,81,302 at the end with 9.51% extended internal rate of return (XIRR). That’s impressive right? Now let’s look at VIP.
If same investor wants to accumulate Rs 3,81,302 within same time frame (five years) without investing anywhere, he has to put aside Rs 6,355 on monthly basis so that at beginning of the second month his money should be Rs 12,710 (6355*2), third month Rs 19,065 (6355*3) and so on. Hence, at the end the investor accumulates desired amount.
Instead of putting aside Rs 6,355, the investor starts investing in Sensex with the first instalment of Rs 6,355 but here the target is to achieve Rs 12,710 at start of the second month, Rs 19,065 at the start of the third month and so on. Now, in January 2014, Sensex went up by 2.96% and Rs 6,355 grew at same rate and became Rs 6,543.Now as the target is to achieve Rs 12,710 at start of the second month, investor will put `6,167 in February 2014 to make it Rs 12,710. Similarly, at start of the third month, the investor will put Rs 5,985 instead of Rs 6,355 as investment grew by 5.99% in February 2014. In some months, the investor has to fetch more than Rs 6,355 like December 2014 where the investor is putting `6,612 because in November 2014, the Sensex fell by 4.16%. Hence idea is clear, when markets are going up invest less and more when markets are coming down.
Now we will see how effective VIP is with help of three scenarios.
The three scenarios
Scenario 1: In this scenario investor wants to accumulate same (or somewhat close) units what he has accumulated using SIP (10.52 units). Investor achieves it in 45 instalments only (10.55 units) instead of 60 but is not able to accumulate Rs 3,81,302. However, a higher return of 11.40% is generated but investor could accumulate Rs 3,50,441 which is not his target.
Scenario 2: The second scenario is investing same (or somewhat nearer) amount of money which investor invests through SIP i.e. Rs 3,00,000. So, the investor is able to invest `3,01,622 in 48 instalments. By doing so, the investor is able to accumulate 11.1 units with Rs 3,99,362 worth of money which is above the desired amount with 14.09% XIRR.
Scenario 3: In this scenario we tried to examine that if investor invests till five years, he is able to accumulate Rs 4,79,826, but is able to generate 9.54% XIRR, lesser to 14.09% in Scenario 2. The reason being, from 48th instalment onwards, the monthly returns are either negative like -6.26%, -4.93% or just 0.29%, 0.52% which dragged down overall return.
Pros and cons of VIP
For retail investors, VIP has its pros and cons and investors should be cautious while investing money. Retail investors need to monitor the portfolio regularly to get maximum return while achieving goal. There are times where VIP might need more money to be put in as we have seen above. So unlike SIPs, outflows from investor’s pocket is unknown and totally market driven. Also, VIP is not suggested for those who have just started investing and have low risk appetite.
The writer is a certified financial planner