Mutual Funds - SIP or VIP

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We all know the answer to the following very simple question buts let's start with the basics anyway, to get a better comparison between an SIP and a VIP:

What is an SIP?

An SIP, or a Systematic Investment Plan, is a mode of investment whereby you, the investor, invest a pre determined amount on a monthly basis, on a pre determined date, into a particular mutual fund scheme. It's the most commonly chosen method of investing by retail investors today.

An SIP has a number of benefits, such as:

·         Benefit of Rupee Cost Averaging
Since you're buying every month, you'll be buying at dips and rises, so you are averaging your cost over the time period.

·         Benefit of Power of Compounding
An SIP of Rs. 5,000 per month, with the help of the power of compounding, can grow to Rs. 13.76 lakhs assuming a growth rate of 15% p.a.

·         Helps you avoid panic selling
SIP investors tend to scare less easily than lump sum investors when the markets fall – as they get the chance to buy low, and later when they want, sell high.

·         It's possible to start small
You don't need a large amount of money to start an SIP, you can start with as little as Rs. 500 per month and slowly build up your wealth.

·         Helps you avoid market timing
An SIP effectively stops you from trying to time the market and inculcates automatic financial discipline into your investing method.

·         One Form, Multiple Regular Investments
An SIP cuts down the paperwork you need to do, with one form you can invest for 10 years or more into your chosen scheme.
An SIP is especially useful for salaried individuals who can save and invest a certain amount each month however the benefits of SIPs apply to all investors.

So what is a VIP?

A Value averaging Investment Plan (VIP) is an investment strategy that works like an SIP – you invest on a pre determined date, into a fixed mutual fund scheme, achieving the purpose of disciplined investing and following the finance gurus when they say 'Buy Low'.

But while in an SIP the amount is fixed and units may change, in a VIP you have a target value of your portfolio, which increases by say Rs. x,000 per month, and you invest the difference between the current value of your portfolio, and the targeted portfolio investment value.

For example, suppose you set a target level of Rs. 5,000 per month. You invest for 2 months (Rs. 10,000 invested totally) and the market falls. So the current portfolio value of your Rs. 10,000 invested, is now Rs. 8,500 (it's in the red). To make up for this fall, you invest Rs. 5,000 for your third month's investment, and also an additional Rs. 1,500 (Rs. 10,000 minus Rs. 8,500). So in the third month, when the market has fallen, you invest Rs. (5,000 plus 1,500) i.e. Rs. 6,500, instead of Rs. 5,000.

Similarly, if the market has risen, and your Rs. 10,000 has grown to Rs. 12,000, then when the time comes to make your third month's investment, you will not invest Rs. 5,000, but instead Rs. 3,000 (Rs. 5,000 minus Rs. 2,000 – the profit you have made due to the market rise). In essence, the VIP bridges the gap between the target portfolio value, and the actual current portfolio value. It buys less when the markets are high and more when the markets are low.

The benefit of this approach is very apparent:
If the markets go down, you invest more, if the markets go up you invest less. So if there is value to be had, if you can buy on the cheap, value investment plans will help you do this. And if the market rises and investments become 'expensive', the value investment plan strategy will ensure you do not invest as much. It might even ask you to redeem some of your investment, booking profits in the process.

By buying more when markets go down, you are also benefiting from rupee cost averaging on the downside. Investing regularly inculcates financial discipline, and again you don't have to worry about too much paperwork.

One thing you need to keep in mind though is that you need to have sufficient cash flows to meet the investment that will be required in market dips, as at these times, you will be investing more – sometimes much more.

Let's see how each strategy works with an example.

Let's take the NAV of an imaginary mutual fund scheme for reference, calling it XYZ mutual fund. We use both the SIP strategy and the VIP strategy, considering XYZ Scheme's NAV's for the last 1 year on a monthly basis. Here we see that in the SIP strategy, investing Rs. 5,000 per month, on a fixed date, we invest a total of Rs. 60,000 per year and accumulate 3143 units totally. This gives us an average unit price of Rs. 19.09 It also gives us a rate of return of 10.56%.

Under the VIP strategy we modify our investment such that if the market dips we buy more, and if it rises we buy less.In this manner, we invest a total of Rs. 60,128 over 12 months, and accumulate a total of 3235 units at an average price per unit of Rs. 18.58. Using the VIP strategy we have a rate of return of 17%.

 

SIP Date NAV SIP Amount (Rs.) Units bought 1-Sep-10 20.00 5000 250.00 1-Oct-10 19.00 5000 263.16 1-Nov-10 18.00 5000 277.78 1-Dec-10 19.00 5000 263.16 3-Jan-11 20.00 5000 250.00 1-Feb-11 21.00 5000 238.10 1-Mar-11 18.00 5000 277.78 1-Apr-11 21.00 5000 333.33 1-May-11 19.00 5000 303.03 1-Jun-11 18.00 5000 277.78 1-Jul-11 17.00 5000 294.12 1-Aug-11 20.00 5000 250.00 Total Units Purchased 3143.12 Total Amount Invested 60,000 Average price per unit 19.09 Portfolio Market Value as on 1-Aug-11 62,862 Internal Rate of Return 10.56%

VIP Date NAV Target Amount Amount Invested (Rs.) Units Bought / Sold 1-Sep-10 20.00 5,000 5,000 250.00 1-Oct-10 19.00 10,000 5,250.00 276.32 1-Nov-10 18.00 15,000 5,526.32 307.02 1-Dec-10 19.00 20,000 4,166.67 219.30 3-Jan-11 20.00 25,000 3,947.37 197.37 1-Feb-11 21.00 30,000 3,750.00 178.57 1-Mar-11 18.00 35,000 9,285.71 515.87 1-Apr-11 21.00 40,000 - 1-May-11 19.00 45,000 8055.56 423.98 1-Jun-11 18.00 50,000 7,368,42 409.36 1-Jul-11 17.00 55,000 7,777.78 457.52 1-Aug-11 20.00 60,000 - - Total Units Purchased 3,235.29 Total Amount Invested 60,128 Average price per unit 18.58 Portfolio Market Value as on 1-Aug-11 64,706 Internal Rate of Return 17%

 

Looking more closely at the VIP strategy you will notice a couple of things:

·         While in an SIP the amount invested each month is the same, in the VIP the amount changes each time. With each market dip, you buy more. When the market rises in the final month and the NAV of the scheme is Rs. 20, you don't invest at all. In certain VIP methods, you would actually redeem some portion of your portfolio and book profits, however in the above example we haven't done so.

·         Not everybody has the surplus funds on a monthly basis to increase their investment depending on market dips, by more than a certain amount. So for salaried people, who know exactly how much their savings and potential investible surplus are, the SIP is a more suitable method of investing. Also, in this strategy, you could be left with some surplus funds (you haven't invested the full Rs. 60,000 in the last 12 months), or you could be left with no surplus funds and slightly strapped for cash. Everything depends on the market movement.

·         The VIP strategy, with its premise of 'Buy Low' tends to generate a higher rate of return with a standard investment strategy such as the SIP. In most scenarios, you will also achieve a lower average cost of acquisition through the VIP.

·         If you were to sell (as it would recommend in rising markets) you would automatically be booking profits, which is a good thing that people sometimes forget to do. However, this can lead to short term taxation and transaction charges.

While both methods may sound similar at first, upon looking closer you'll see that they're actually quite different.

It's up to you as an investor to know what you can and should do. Also, if you have a Financial Plan, then you need to invest a fixed amount across certain schemes for the long term, and avoid market timing altogether. The SIP would be more suitable for you than the VIP.

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