SIP vs VIP

SIP - Systematic Investment Plan

An SIP is a mode of investment whereby the investor, invest a pre-determined amount on a monthly basis, on a pre-determined date, into a particular Mutual Fund Scheme. It is the most commonly use method of investment by individual investor today.

Advantages of SIP

• It gives an investor a benefit of rupee cost averaging. As investor buying every month, so he or she will be buying at dips and rises. So, over the time period investor is averaging his/her cost.
• It gives an investor a power of compounding.
• It helps an investor to avoid panic selling.
• An investor can start investing with a small amount of money say 500 rupees.
• An SIP effectively stops you from trying to time the market and bring financial discipline into investors investing method. 
• An SIP cut downs paper work which investor need to do,  with single form an investor can invest for 10 or more years into your chosen MF scheme. 

  

VIP - Value Averaging Investment Plan 

Value Averaging Investment Plan is an investing strategy that actually works on similar terms of steady monthly contributions as SIP, but it differs in its approach to the amount of each monthly contribution. In value averaging, the investor sets a target growth rate or amount on his portfolio each month, and then adjusts the next month's contribution according to the relative gain or shortfall made on the original portfolio.

Advantages of VIP

• It invests more rupee amount when markets are lower and less when markets are higher.
• In most cases it generates higher returns than normal SIP which is based on rupee cost averaging.
• It achieves lower cost of acquisition in most scenarios as compared to SIP.
• The probability of achieving target value for a portfolio is much higher and hence ideal for financial planning.
• Longer the investor horizon, higher the benefits from it.

Challenges in VIP

• The sum which investor invest each month will be highly unpredictable. So, its difficult for salaried individual whose income is constant to commit to a VIP knowing that the sums debited to his account may vary so widely. 
• In long term and constantly falling markets the investment amount may increase mush beyond the investor's cash flow.
• VIP is most effective when the market is not moving in one direction. If on starting the VIP the market is in steady decline foe many months, investors in a VIP would find themselves committing   larger sums to the equity fund, even while the investment loss value.
• In rising market it generates sell which may result in unwarranted short-term taxation and transaction charges.

Let's see how both the strategies works with an example :- 

Suppose, we are investing in any ABC mutual fund. We use both the strategies, considering that ABC Scheme's NAV's for last one year on a monthly basis. While investing in SIP Strategy, we invested Rs. 5000 per month, on a fixed date, we invest a total of Rs60000 per year and accumulate 3378 units totally. This gives us an average unit price of Rs. 18.30 with rate of return of 20.86%.

Under VIP strategy, we modify our investment every month such that if market rise we purchase less and if it dips we buy more. we invest a total of 57446 over 12 months and accumlate total 3235 units at an average price of 17.76 with rate of return 26.42%.

SIP
Date	NAV	SIP Amount (Rs.)	Units bought
1-Sep-10	20	5,000	250
1-Oct-10	19	5,000	263.16
1-Nov-10	18	5,000	277.78
1-Dec-10	19	5,000	263.16
3-Jan-11	20	5,000	250
1-Feb-11	21	5,000	238.1
1-Mar-11	18	5,000	277.78
1-Apr-11	15	5,000	333.33
1-May-11	16.5	5,000	303.03
1-Jun-11	18	5,000	277.78
1-Jul-11	17	5,000	294.12
1-Aug-11	20	5,000	250
Total Units Purchased	3,278.23
Total Amount Invested	60,000
Average price per unit	18.3
Portfolio Market Value as on 1-Aug-11	65,565
Internal Rate of Return	20.86%

VIP
Date	NAV	Target Amount	Amount Invested (Rs.)	Units Bought / Sold
1-Sep-10	20	5,000	5,000	250
1-Oct-10	19	10,000	5,250.00	276.32
1-Nov-10	18	15,000	15,000.00	833.33
1-Dec-10	19	20,000	20,000.00	1,052.63
3-Jan-11	20	25,000	25,000.00	1,250.00
1-Feb-11	21	30,000	30,000.00	1,428.57
1-Mar-11	18	35,000	35,000.00	1,944.44
1-Apr-11	15	40,000	40,000.00	2,666.67
1-May-11	16.5	45,000	45,000.00	2,727.27
1-Jun-11	18	50,000	50,000.00	2,777.78
1-Jul-11	17	55,000	55,000.00	3,235.29
1-Aug-11	20	60,000	-	-
Total Units Purchased	3,235.29
Total Amount Invested	57,446
Average price per unit	17.76
Portfolio Market Value as on 1-Aug-11	64,706
Internal Rate of Return	26.42%

(Source : PersonalFn )

Both the methods sound similar at first place, but after looking closely you'll see that they are actually quite different. Above example suggest that the VIP delivers a higher return on an average as compared to SIP. As an investor its up to you what you can and should do. If you have financial plan, then I would suggest that you need to invest a fixed amount across certain scheme for long-term and you need to avoid market timing altogether. in that case, SIP would be more suitable for you than VIP.

How to select right Debt Fund.. ???

When we think about investment in mutual funds then first option we all think about is Equity Funds or Diversified Funds, and in this post I will explain how to choose the right Debt Fund. First, lets see what is Debt Fund.. A debt fund is a professionally managed funds, which invest money in Government Securities, Money Market Instruments & Corporate Deposits. These mutual funds include a small percentage of equity investment of around 10% in their portfolio to give investor capital appreciation. So, debt fund are associated with little investor risk too.

Most of the mutual fund investor think that choosing a debt fund is easy then chooising equity fund whereas on contrary, I would like to say selecting a debt fund is more problematic because of large number of categories available - Liquid, Income, Short-term, Ultra Short-term, Gilt, Monthly Income plans, Fixed Maturity plan etc. Though fund selection requires some basic criteria - risk profile, consistency in performance, quality of underlying paper & fund manager's track record etc.

Key parameters for choosing a right Debt Funds are:- 

Time Horizon & Fund Maturity - If you want to go for debt fund then first, you should ascertain the period for which you want to stay invested because each category has different maturity profile. Ideally, investor need to match its time horizon with that of the fund.

For example :- you are looking for investment for a period of 3month then investor should not invest in liquid or short-term fund instead they should go for Ultra Short-term fund where average maturity of fund is upto 90 days. For 1 year or more, Income fund or fixed matruity plans are the best option.

Note :- Short-term gains in debt funds are taxed according to the applicable tax slabs whereas Long-term gains are eligible for the inflation indexation benefits.

Quality of underlying papers - Before investment in debt fund investor should scrutinised the quality of debt instrument in the fund's portfolio. Every instrument is assigned a credit rating that signifies the level of default risk. Higher the rating, the safer the instrument. To check whether the instrument are safe or not, investor can go through the offer document as well as the subsequent fact sheet publised by the mutual fund. A debt fund may invest in number of instrument ranking from risk-free goverment securities to high-risk corporate paper As the safety of capital is of utmost importance to a debt investor and a fund holding large amount in a poor quality paper may find it difficult to sell such securities in the market, thereby putting the money at risk while its true that a debt fund with a risky paper is likely to yield higher returns, it may work unfavourably for the investor. So, investor should go for funds which have low quality investments.

Interest Rate scenario - Debt mutual funds are exposed to interest rate risk as they tend to go up in value when interest rate fall and vice-versa. This is because of the inverse relationship between bond prices and interest rate. However, short-term debt funds are less sensitive to movements in interest rate in comparison with the long-term funds. So, it is advicable for investor that when interest rate are on the rise it makes sense to move to short-term funds and vice-versa.

For example:- if you had invested in a deposite one year ago, you could have got 10% annual rate of return. A similar deposit today would fetch only a 7% per annum rate of return. If you were allowed to get the 10% per annum deposit today, you would probably be willing to pay a premium for it.

Expense Ratio - Debt funds have lower returns, expense become very critical as a higher expenses ratio eats into the investor's returns. As most of the debt funds offer returns in the range of 7%-10%, having an expensive cost structure will be huge drag on the returns. So, it is very important for investors to ensure that the cost structure is reasonable & in line with the return being offered by the fund. For example:- it doesn't make sense to pay a charges of 2.25% for a return of 3-4% and if you adjust for inflation then you are effectively earning a negative returns on your investment.

Size of the fund - While one can argue that size doesn't matter in equity funds, in the case of debt funds, it does assume greater significance. A small corpus may not hurt equity fund investors, but could affect debt fund investors. From time to time, debt mutual funds could see large redemptions, as happened in the case of Lehman Brothers crash. If the fund size is large, the fund manager can meet these redemptions out of his cash holdings. He also has more choice regarding which instruments to sell off to meet these redemptions. The manager of a small fund doesn't have as much leeway and has to perforce book losses. Hence, while in equity funds a large fund size can pose problems (the fund manager needs many more investment ideas to earn high returns), in debt funds large size can be an asset as it helps produce stable returns.

Fund Manager's track record - Past performance data for a debt fund no longer remain relevant if the fund manager who bring back those returns has left the fund. A good investment strategy would be to track the performance of star fund managers and move your investment with them when they move from one fund to another. If the fund manager is same and fund performance is consistent across interest rate cycles, it implies the fund manager is moving smartly between different types of debt instruments and making the most of the volatility.

These are the factor which an investment need to analysis investing in debt fund. At the end, I would like to say "In financial markets, the fastest does not always win; the winer is the one who is better prepared and more balanced."