SIP vs VIP - Which Investment Strategy is Right for You?

Benefit of Power of Compounding:

If started at an early age, SIP helps you to start investing to meet the greater expenses of your life. Saving a small sum of money regularly makes your money work with greater power of compounding with significant impact on wealth accumulation.

Helps you avoid panic selling:

SIP investors tend to scare less easily than lump sum investors when the markets fall - as they get the chance to buy low, and later when they want, sell high.

It's possible to start small:

You don't need a large amount of money to start an SIP, you can start with as little as Rs. 100/- and slowly build up your wealth.

Helps you avoid market timing:

An SIP effectively stops you from trying to time the market and inculcates automatic financial discipline into your investing method.

One Form, Multiple Regular Investments:

An SIP cuts down the paperwork you need to do. With just one form you can invest for 10 years or more into your chosen scheme.

An SIP is especially useful for salaried individuals who can save and invest a certain amount each month; however the benefits of SIPs apply to all investors.

Making investments in stock markets via Systematic Investment Plan (SIP) has been proved as a successful strategy which helps you to play safe given the volatile nature of stock markets.

Investment in a Value averaging Plan (VIP):

A Value averaging Investment Plan (VIP) is an investment strategy that works like an SIP – you invest on a pre-determined date, into a fixed mutual fund scheme, thus achieving the purpose of disciplined investing and following the teachings of finance gurus when they say 'Buy Low'.

But while in an SIP the amount is fixed and units may change, in a VIP you have a target value of your portfolio, which increases by say Rs. x,000 per month, and you invest the difference between the current value of your portfolio, and the targeted portfolio investment value.

For example, suppose you set a target level of Rs. 5,000 per month. You invest for 2 months (Rs. 10,000 invested totally) and the market falls. So the current portfolio value of your Rs. 10,000 invested is now Rs. 8,500. To make up for this fall, you invest Rs. 5,000 for your third month's investment, and also an additional Rs. 1,500 (Rs. 10,000 minus Rs. 8,500). So in the third month, when the market has fallen, you invest Rs. 5,000 + 1,500 i.e. Rs. 6,500, instead of Rs. 5,000.

Similarly, if the market has risen, and your Rs. 10,000 has grown to Rs. 12,000, then when the time comes to make your third month's investment, you will not invest Rs. 5,000, but instead Rs. 3,000 (Rs. 5,000 - Rs. 2,000 = Rs 3,000– the profit you have made due to the market rise). In essence, the VIP bridges the gap between the target portfolio value, and the actual current portfolio value. It buys less when the markets are high and more when the markets are low.

The benefits of this approach is very apparent:

If the markets go down, you invest more and if the markets go up you invest less. So if there is value to be held, and if you can buy on the cheap, value investment plans will help you do this. And if the market rises and investments become 'expensive', the value investment plan strategy will ensure you do not invest as much. It might even ask you to redeem some of your investment, booking profits in the process.

By buying more when markets go down, you are also benefiting from the concept of rupee cost averaging. Investing regularly also inculcates financial discipline, and again you don't have to worry about too much paperwork.

One thing you need to keep in mind though is that you need to have sufficient cash flows to meet the investment that will be required in market dips, as at these times, you will be investing more – sometimes much more.

In Table 1 we have used both SIP and VIP strategies, and considered the Scheme's (Fund Q) NAV for investments for a period of 12 months from 3rd April 2006 to 1st March 2007 on a monthly basis. Here we see that in the SIP strategy, investing Rs. 5,000 per month, on a fixed date, for one year, we invest a total of Rs. 60,000 per year whereas in VIP we invested Rs. 56,544 and accumulated 5,492.24 units and 5,208.33 units respectively. While the returns for the first year look more positive towards VIP, but if we look at it from a long term perspective you could see in the span of four years after the completion of one year of SIP / VIP Investment, both SIP and VIP returns tend to converge at a certain point. The difference between the overall rate return for SIP and VIP is less than 0.50%.

While both methods may sound different at first, and their rate of returns has a decent difference because of Market timings but in a practical scenario the benefits may not be achieved on account of associated costs of transactions like STT, Exit Loads, requirement of cash, etc, looking upon closer you'll see that they actually converge over a period of time. If you refer to the above example you can notice that 3-5 years after completing a 12 month VIP, the returns under the VIP method and SIP method are almost same. The convergence of Returns happens post the last payment of installment of SIP / VIP over a period of time wherein the true benefits of Equity Investments gets captured. To reaffirm our stance we have shared with you a detailed 5 year example which initially at different levels might show SIP and VIP performing better than the other but ultimately in the long run (refer attached 5 year example) both the investment processes converge and give similar returns.

Equity investments should be for longer period of time and if made in installments it should follow a disciplinary approach and SIP scores over VIP in ensuring discipline of investments and over a long period of time gives returns similar to that of VIP while doing away with risks of forced redemption or requirement of additional surplus cash for investments. SIP captures the potential of extracting a better valuation when investing in falling markets while it also averages out risk of investing in a rising market thus ensuring true cost averaging resulting in a final better value.

Therefore to conclude, a simple disciplined approach to investing through SIP is a good move toward generating wealth in the long term. Unless you are a financial wizard you may not be able to achieve long term wealth generation by timing the market and changing your holding patterns regularly.

Some of us have mapped our financial goals via a Financial Plan, wherein we may need to invest a fixed amount across certain schemes for the long term, in a disciplined manner and avoid timing the market altogether.

Ultimately it is up to you as an investor to choose between SIP and VIP since you understand your investment objective the best; whether you would like to opt for a disciplined investment process through SIP or a marginally better returns option through a VIP with the need to continuously rebalance your portfolio.

For further information on SIP and VIP please do not hesitate to get in touch with us on [email protected] or on 1800-22-3863