Use SIPs to fight market volatility

A value investment plan (VIP) is a new investment option launched by a few mutual funds. This concept may gain popularity in the times to come. A VIP is supposed to be a better form of the SIP (systematic investment plan).

A VIP too follows the averaging concept. This investments strategy also works on monthly contributions. The differentiating point is the approach to the amount of each monthly contribution as compared to a SIP.

In case of a VIP, you have to set a target growth rate or amount for each month, and then adjust the next month's contribution according to the relative gain or shortfall made on the original portfolio. In this case, you have to invest more when the market prices fall. On the contrary, you have to invest less when the stock prices rise.

Your investment pattern follows the market. You buy more when the prices are low and invest less when the markets are rising - the ideal thing an investor should do. The investment pattern mirrors the market trend. For example, assume you want to add Rs 5,000 per month to your mutual fund portfolio, and on the first of the month you invest Rs 5,000. Next month say the value of your investment is Rs 5,200. So, you will invest Rs 4,800 only next month rather than Rs 5,000. The balance is contributed by selling securities of an equivalent value (Rs 200 in this case).

In the third month, let's say the value of your investment falls to Rs 8,000. You will have to contribute Rs 7,000, so as to make the target amount of Rs 15,000 (Rs 5,000 for three months). This roll-over goes on during the specified period .

With this plans, you invest a higher amount when the markets are going down. Similarly, you invest a lesser amount when the markets are going up. This is precisely what investors should do. An investor cannot predict the direction of the markets. The VIP mode of investing helps synchronise the investment amount with the market movements . In contrast, a SIP mode of investing is based on the principle of rupee cost averaging. The cost of acquisition in VIP is usually lower vis-a-vis a SIP.

Another difference from a SIP is that each month the amount to be invested will vary. In case of a SIP, a fixed amount is invested each month. In case of a VIP, the difference between the target value and the portfolio's actual market value is to be invested.

So, you cannot really plan out the cash flows with precision, because the amount to be invested is based on the market values, which itself is volatile. In case there are prolonged bear market phases, the amount required to be invested will be much higher. The point to be kept in mind is that if a bear phase continues, let's say for 3-4 years, it can be value eroding for an investor. He will continue investing in a falling market.

In case of bull phases, the incremental investments to be made will be smaller. So, in case one expects a cash crunch, it is advisable to fix a lower target rather than go aggressive and fix a higher target. Usually, in the long term, a VIP is expected to give better returns than a SIP. This is mainly because investments are automatically triggered as the markets fall. The basic premise is that money is invested in periodic intervals in a portfolio in such a manner that the portfolio tries to approach a target rate of return.

Source: http://articles.economictimes.indiatimes.com/2011-09-04/news/30112692_1_investment-plan-new-investment-option-investment-pattern