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SIP, One-time or VIP, the best investment strategy

Most people are aware of Systematic Investment Planning (SIP) i.e. the process of investing a small fixed amount regularly in a mutual fund scheme. It also goes by the name Rupee Cost Averaging.

The idea is to spread out one's investment in the equity market, so that the volatility risk is minimized. This ensures better chances of lower average cost of acquisition, when compared to making a one-time lump sum investment... and hence the term rupee-cost averaging.

Suppose we have Rs.12,000 to invest. We, therefore, invest Rs.1000 every month instead of investing entire Rs.12,000 at one go.

Accordingly, for Rs.1000 invested invested every month
(a) we receive more units, when the NAV is down, and 
(b) lesser no. of units when the NAV is up.

Assuming that the markets are volatile and the NAV is fluctuating, systematic investment results in acquiring more no. of units for the same total amount invested vis-à-vis one time lump-sum investment. In other words it reduces the average cost/unit purchased.

There is, however, another strategy which also involves making small and regular investments... but with a difference.

In this, the monthly amounts invested are 'not fixed'. In other words, your investment amount varies month after month. Proposed by Michael Edleson of Harvard Business School, it is called Value Investment Plan (VIP) and goes a step further than the SIP. 

Value Investment Plan

Under VIP we work backwards i.e. we decide on the amount we must accumulate by the end of a given period. 

Suppose, I need Rs.12,000 after one year. And I want to reach this amount systematically i.e. total value of my investment in the 2nd month should be Rs.2000, Rs.6000 in the 6th month, Rs.10,000 in the 10th month and so on till I have Rs.12,000 in the 12th month. 

Accordingly, every month I work out the value of units acquired till the previous month. Then I invest such amount, which will make the total amount equal to the desired total value for that month. Therefore, while the investment is regular, the amounts are not necessarily the same.

Herein, as compared to rupee cost averaging, we end-up 
(a) investing more money when the NAVs are down, and
(b) less money when the NAVs are up. 

In fact in some months we may even end-up selling instead of buying. 

Our investment is guided by the value the market offers – more value when the NAV is down and less value when the NAV is up. Hence it is also known as Value Averaging. 

Normally, the average cost per unit under VIP would still be lower than under SIP. Hence the returns would be that much better.

Comparing One-time, SIP and VIP Investment Pattern

I now take up a generic example, to demonstrate and compare the returns under SIP, VIP and One-time investment strategy.

As you would observe from a typical example given below:
- Rs.12000 invested on 01/01/12 will fetch 479.04 units
- Rs.1000 invested every month fetches 521.99 units. 

SIP vs VIP vs One-time Investment
Thus the average cost/unit under SIP is lower at Rs.22.99/unit as against Rs.25.05/unit under one-time investment.

But what about VIP? 
- Suppose I invest Rs.1000 on 01/01/12 @Rs.25.05/unit. 
- But next month the NAV falls to Rs.23.60. As such the value of my investment reduces to Rs.942. Therefore, to have the desired investment value of Rs.2000 in the 2nd month, I need to invest Rs.1058 (Rs.2000 – Rs.942). 
- Similarly, at the beginning of 5th month when the markets are up, the value of my earlier investments work out to Rs.4385. Therefore I need to invest only Rs.615 to reach the target of Rs.5000. 
- And, at the beginning of 10th month, the value of my earlier investments work out to Rs.11,515 as against the target of Rs.10,000. Thus I sell units equivalent to Rs.1515. 

Accordingly, the average cost per unit under value averaging is still lower at Rs.21.66 vis-à-vis Rs.22.99 under SIP.

Thus, Value Investment Planning has the potential to deliver the best returns among the aforesaid three investment strategies.

However, value averaging has one drawback. We have to monitor and adjust our investment every month (vis-a-vis the passive SIPs, wherein we have to give our instructions just once and thereafter the investment happens automatically.)

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