Value-averaging investment plan (VIP) is a new method of systematic monthly investment which is slightly different from Systematic Investment Plan (SIP). In VIP the monthly contribution amount varies from month to month unlike SIP depending on the market performance. The concept is very simple, Increase your contribution when last month return is less than expected and decrease your contribution when last month return is more than expected.
The investment Strategy which I will be discussing in my current as well as next posts, will prove to be a paradigm shift in investments. We all know that we should invest more when market falls or crashes and restrict investing or rather sell when markets rise, but as a retail investor can we time the market and really follow what we know? Is there any calculator in the world which tells us when we should buy more or when we should sell? Someone has rightly said "Be cautious when markets are aggresive and be aggresive when markets are cautious" and this post will give you concrete mathematical way of following this.
How it works?
We need to decide on 4 things to start a VIP
Base Contribution per month
Maximum Contribution amount
Investment tenure
Minimum Contribution amount
Expected rate of return
Lets assume that I expect a return of 12% annually on my investments with maximum monthly contribution of Rs15000.
Here I decide that my base contribution is Rs 5000 per month with 1% monthly expected rate of return.
Scenario1
At the end of first month, suppose I get 1.5% monthly return amounting to Rs 75 against the expectation return of Rs 50 @1%. My expected portfolio value comes to Rs. 5075 against the expected value of Rs. 5050. Here I am Rs25 plus than expected rate of return, so next month instead of investing Rs 5000, I will Invest Rs. 5000 minus Rs. 25 i.e. Rs. 4975.
Scenario 2
At the end of first month instead of expected return on portfolio value of Rs. 5000/- @ 1% which amounts to Rs 50, I manage to get negative returns of -1% i.e. loss of Rs 50 the portfolio value taking it to Rs 4950 instead of Rs 5050. My portfolio value is Rs. 100 less than expected. Next month, instead of investing Rs. 5000 I will increase my contribution by Rs. 100 taking it to Rs. 5100.
Scenario 3
If at all last month return is exactly same as expected then there will be no change in my next month’s contribution.
How it fares in Comparison to SIP
It is very easy to analyze that by this way, we tend to invest more when markets are negative and invest less when markets are performing which is a thumb rule of investing. Considering that markets give average return of 12% over a period of 5 years, this type of investment strategy would give higher returns than traditional Systematic Investment plan (SIP). Returns could be higher to the tune of 3% or higher depending on the risk variable you choose.
Although VIP is a new concept, and I have already explained the difference above, is there any relation between SIP and VIP apart from that the investments are systematic? After giving a lot of thought I have managed to find the relation between SIP which you will not find in any books, anywhere in the world.
SIP, derivative of VIP
SIP is a type of VIP, rather SIP is subset of VIP. Having said that, I mean that VIP is father of SIP. How?
SIP is a type of VIP, rather SIP is subset of VIP. Having said that, I mean that VIP is father of SIP. How?
In the above scenarios, I have an expected portfolio size at the end of every month. However in the above scenario I am just maintaining the portfolio as per expected return by increasing or decreasing the next month’s contribution. Whatever is the loss or profit every month in comparison, we decrease or increase next contribution by that particular amount. What if we add a multiplier to it? Lets say I expect my portfolio to be Rs. 5050 next month which actually happens to be 5000 only. Instead of increasing the contribution in next month’s installment by Rs. 50, we can choose a multiplier, lets assume 3 for illustration purposes. So instead of increasing my contribution by Rs. 50, I will increase it by Rs. 50 *3 (chosen multiplier) i.e. Rs. 150 taking it to Rs. 5150.
In other Scenario if at all actual return is Rs 5100, i.e. Rs. 50 more than expected, instead of Rs 5050, instead of decreasing next month’s contribution by Rs. 50 only, we decrease it by Rs. 50*3 (chosen multiplier) i.e. Rs. 150 taking my next monthly contribution to Rs. 4850.
Hence we can decide the multiplier,(henceforth called Risk variable or Coefficient) as per our wish. Risk variable (Coefficient) can be of any value and even in decimals.
Now, when we set the Risk variable (Coefficient) 0, the scenario becomes exactly what SIP is. So, we can say 0 Risk variable (Coefficient) VIP is SIP.
Now, assuming same horizon of investment with same returns and paying installment on same dates, return in VIP i.e. SIP with > 0 Risk variable (Coefficient) we get higher returns which would vary on the Risk variable (Coefficient) value.
Please the the illustration attached in which base contribution is Rs. 5000 and with VIP with Risk variable (Coefficient) 1 with assumed monthly returns.
Also published the working done in spreadsheet(Please click the link provided below)
VIP Calculator
You can download this VIP calculator and use for your own calculation. You can analyze different scenarios by changing the values in coloumns C, D, G and K i.e. Installment amount, expected return%, actual return% and Risk variable/Coefficient. It will automatically update the output and show you the illustration. Please don’t change any formulae as it will result in giving you incorrect statistics. This might be slightly difficult to understand if you dont know how to Use Microsoft excel or Google spreadsheet but you are invited to ask questions or any other clarification required in the comment section. I will try to make it simple further for you to understand.
VIP Calculator
You can download this VIP calculator and use for your own calculation. You can analyze different scenarios by changing the values in coloumns C, D, G and K i.e. Installment amount, expected return%, actual return% and Risk variable/Coefficient. It will automatically update the output and show you the illustration. Please don’t change any formulae as it will result in giving you incorrect statistics. This might be slightly difficult to understand if you dont know how to Use Microsoft excel or Google spreadsheet but you are invited to ask questions or any other clarification required in the comment section. I will try to make it simple further for you to understand.
Just change the Risk variable value to 0 in all months and you will see that VIP becomes exactly like SIP. You can change actual return value as per the last 5 years actual monthly return trend and find out that returns as well as net yield are higher than SIP
Few Questions which I will be answering in my next post
- How do I implement VIP?
- Is there any mutual fund or ULIP product which is offering this presently?
- How to choose and use the Risk variable or Coefficient?
- How increasing or decreasing the risk variable effects my investment?
- Does selecting higher risk variable means I am taking high risk and will get higher return?
- How will changing the risk variable later effect my Investment?
- Can I change risk variable every month?
- What Happens if I Select Negetive Risk variable?
- When we should change the risk variable in order to get maximum from my investment?
- I am a very conservative investor what is the risk variable I should choose?
- I am a very aggresive investor what is the risk variable I should choose?
- Markets have fallen, Should I increase or decrease the risk variable?
- Markets have touched a new high or there is a drastic increase in Nifty last month, what would be the best risk variable for me in both cases?
- What are the disadvantages of VIP?
