SIP, STP, and VIP, VTP – analysis
SIP, STP, and VIP, VTP – analysis
Everyone knows SIP. This is nothing but cost averaging, popularly known as DCA or Dollar Cost Averaging. Indians did not like this word and chose to call it SIP – Systematic Investment Plan. You invest a fixed sum every month for a longer period. When the price of the stock is less, you buy more units and when the price is high, you buy fewer units. At the end of duration, you would own more units that are bought at lower prices than higher prices. Further it also helps the investor to live through the price volatility of the underlying stock, give some emotional comfort.
This strategy is particularly recommended for buying equity mutual funds, individual stocks, gold and other bullion. This strategy is not particularly useful against fixed income products, bonds and debt mutual funds. Because these products don’t have price volatility and also they start working from day one earning interest, you don’t want to delay picking them up.
There is another strategy called Value Averaging which works better than Cost Averaging most of the times and is recommended by several financial professionals worldwide. What is VA or Value Averaging ? And how does it work ?
Investopedia explains ‘Value Averaging’For example, suppose that an account has a value of $2,000 and the goal is for the portfolio to increase by $200 every month. If, in a month’s time, the assets have grown to $2,024, the investor will fund the account with $176 ($200 – $24) worth of assets. In the following month, the goal would be to have account holdings of $2,400. This pattern continues to be repeated in the following month.
The main goal of value averaging is to acquire more shares when prices are falling and fewer shares when prices are rising. This happens in dollar cost averaging as well, but the effect is less pronounced. Several independent studies have shown that over multiyear periods, value averaging can produce slightly superior returns to dollar-cost averaging, although both will closely resemble market returns over the same period.
If C.A. buys more units when the prices are down, V.A. buys more units than CA. And if CA buys less units when the prices are up, VA would buy even fewer units. As you see with this explanation, VA is much superior to Cost Averaging technically. VA may beat CA in any academic exercise. But practically it poses some important issues. I recommend SIP (Cost Averaging) to most of my clients instead of Value Averaging.Reasons:
(1) VA result in irregular cash flow and may demand more money from your savings account unexpectedly, disregarding your other financial commitments. Imagine, the market goes down and instead of 50K, V.A. demands 65K debit from your salary account. At the same time, you need money for Diwali or family vacation and there is no 65K balance in the account, only 50K is available. Instead of investing 65K, in that particular month, the entire investment transaction would fail. When more money is needed, nothing gets invested; this causes major impact to the strategy and to your portfolio return. Because a check is usually paid in full or bounced, never partially honored.
(2) On the other hand, let us say the market is doing well, the NAV is high, instead of 50K regular investment, only 40K is taken for investment, what would you do with remaining 10K that is left over in bank account ? Spend ? Or invest ?
I guess you like that to be invested as well, for long term. Won’t you feel after 6 years, that extra 10K should have been used to buy more stocks ?
As an investor, I like that extra 10K to be put for better use than spending.
That brings us back to our original old strategy – SIP or Cost Averaging. This is the reason I recommend Cost Averaging over Value Averaging for most of my investors. CA is simple, easy to manage, gives you complete financial control over your savings and investments and let the investor sleep peacefully.
There may be still few of you, who still believe that Value Averaging can be modified to our needs and made to work for us delivering the better returns without scarifying too much on the cash flow issue. One such person started working on a solution and got us two value added products. The person is – Mr.Srikanth of Funds India.
His technical team rolled up their sleeves and delivered two beautiful solutions – VIP and VTP.
VIP is simply the SIP with an upper limit and lower limit for money transfer from bank. I concede it has limited use and would work for some. But I still love the simplicity of SIP.
But I can’t ignore the VTP like that. I love this idea. The subject of the article is VTP, so read carefully.
Before you understand VTP, you should understand what STP is. STP stand for Systematic Transfer Plan. Thereby, you transfer fixed sum from one mutual fund to another mutual fund on a fixed interval. Simple and very useful strategy.
I use this strategy a lot. While some investors start from scratch when it comes to investments, most of my clients start with a lumpsum. We all know lumpsum strategy is not good for equity or gold investments or generally for investments where NAV fluctuations are very high. To solve the problem of lumpsum investing in equity mutual funds, we can use STP.
Step-1: Move the lumpsum money to a liquid fund or ultra short term bond fund without any exit load. This way the money is moved from savings account yielding 4% to safe liquid fund yielding 9%.
Step-2: Setup STP to move money from this liquid fund to selected equity/gold fund at monthly interval for predetermined duration. I usually recommend min of 6 months and max of 18 months. This interval is chosen by various factors – asset size, investment size, age of the investor, goal time horizon, investment size, risk profile, type of fund chosen, tax regulation etc. Leave this dirty job to RRK Advisory. We are good at this. [ Less than 6 months, you wont capture the volatility, this means it would become lumpsum investing. More than 18 months, you would have stored most of your money for longer duration in liquid instrument. Since market always has upward bias, this is not right for very long duration. ]
Step-3: Go Fishing! This strategy works fine, when you don’t disturb the setup.
I guess now you can appreciate the usefulness of this STP strategy. Now consider this. Instead of transferring a fixed sum from liquid fund to equity fund, what if, I can transfer variable amount following the value averaging method, explained earlier.
#1) We don’t have cash flow problem, because all the money is already reserved and stored in a liquid fund
#2) we also don’t have yield loss problem, because the money unutilized in a month is still working at 9%.
This exactly is VTP. (Value Averaging Transfer Plan).
If any of you are contemplating to bring lumpsum money from abroad or your fixed deposit or by selling a real estate, don’t be afraid anymore, bring them on. We have an excellent strategy in place to take care of lumpsum investing.
I am currently converting several STP into VTP. If you like us to help you, please call us at your convenience.