Understanding the difference between SIP and VIP
There is a cardinal principle of making money in investing world. You need to buy low and sell high to make money in any investment. But for various reasons, be it behavioural and otherwise, investors fail to follow and hence may not make money. However, there is a concept called Value Averaging Investment Plan (VIP) that utilizes the same concept to make money for you.
What is a Value Averaging Investment Plan (VIP)?
Investment in VIP is very much like SIP where you invest every month in a selected mutual fund at a pre-determined frequency. However, the amount you invest is not the same as in the case of SIP. In the case of VIP, the amount keeps on changing according to the performance of the market. Under VIP you set a target value of your portfolio that you want to achieve at the end of a period. Now you work backwards to achieve that target investment value every month. Here you vary your investment every month based on the market performance and total value of your investment.
Example
If as an investor you want to buy a car 24 months from now, that is valued at Rs 600000. Working backwards, you need to save and invest at least Rs 25,000 per month over the next two years in your mutual fund portfolio (for simplicity we are assuming no returns). In the first month, you invested Rs 25,000. In the second month, your fund performed better and now your fund value increased to Rs 27,000. Now in the second month, you need to invest only Rs 23,0000 as this will add up to Rs 50,000. In the third month, however, the market nosedived, and the investment value declined to Rs 48,000. Now to make up his portfolio value to Rs 75,000, the investor needs to invest Rs 27,000.
The above example clearly shows that when the market is high, VIP makes us invest less, while it forces us to invest more when the market is low, helping us to follow the classical strategy of “buy low and sell high”. One drawback of this strategy is you do not know beforehand what is amount you need to invest every month. Hence, you need to have extra liquidity to cover up any shortfall.
Another disadvantage of VIP is that you may not invest during the bull run. This is the case in the current scenario where in the last one year Nifty 50 has increased by 53 per cent or around 4 per cent every month. So, depending upon your requirement, every month you will continue to contribute less towards your goal.
Nonetheless, VIP is mostly used by investors to achieve a target value for some specific purpose, like a car in the above example.