Learn how to invest using the value averaging method.
Value averaging investment plans (VIPs) are related to their more well-known cousins, dollar cost averaging and systematic investment plans (SIP). Former Harvard professor Edelson initially proposed the concept of a value averaging investment plan in 1988. It adheres to the traditional investment strategy of purchasing low and selling high.
What exactly is a VIP?
An investor who follows this investment philosophy sets a target, a final sum or corpus that he wants to reach during the holding time, and then invests in accordance with market movement. As a result, a value path is formed, directing the investor as to what the portfolio’s worth should be at any particular point in time.
Investors ensure that the portfolio value is as close to the value path as possible. If the portfolio value is below the value path, investors must increase their investment. This is a formula-driven technique, and as a result, the investor buys more at low prices and may not buy at all at high prices. As a result, this approach differs significantly from the frequently utilized SIPs.
SIP vs VIP
SIPs are based on rupee cost averaging, and the investor invests a pre-determined amount every month/quarter, regardless of market fluctuations. As a result, if the market falls, the investor will buy more units but not necessarily invest more money.
Let’s have a look at the mechanics of SIP and VIP by assuming a monthly investment of Rs 10,000 in both plans with a 1% expected rate of return. As a result, when the second instalment is due, the invested value should have increased to Rs 10,100. However, due to market fluctuations, the actual worth is Rs 9,500. The SIP investor would keep their Rs 10,000 investment, while the VIP investor will make a Rs 10,600 investment to make up for the Rs 600 gap (Rs 10,100 minus Rs 9,500). The first two instalments are scheduled to total Rs 20,301 by the third month.
Let’s say the market rises 4% in the second month, bringing the total invested value to Rs 20,904. Because the present value exceeds the target value, the monthly investment will be lowered by Rs 603 (i.e. Rs 20,904? Rs 20,301), and the VIP would be Rs 9,397. This method is repeated month after month in VIP until the goal date is reached. Regardless of the portfolio’s current market value, SIP will continue to invest Rs 10,000 per month.
Advantages of VIP
It requires investors to begin with the end aim in mind and even permits them to sell if market conditions are favorable. It is feasible to change the end aim if necessary, under this scenario. In addition, market returns and inflation might be considered when determining the value journey.
The monthly investment amount is fixed with SIP, but the portfolio value is bigger than the investments made. The portfolio’s value is fixed with VIP. The cost of investing is frequently less than the portfolio’s value. To summarize, both principles are effective in a variety of market scenarios and shield investors from the danger of market volatility.