Cost Averaging/SIP and Value Averaging are perhaps the two most talked about investment approaches with regards Mutual Fund investments.
Most people have knowledge about Cost Averaging AKA SIP but Value Averaging is not well known in India.
In this article, we will go through these two approaches and compare them.
Let’s talk about Cost Averaging first
This elementary investment method is about investing a fixed sum at regular intervals – more than often monthly.
The reason behind this approach is help investors catch different market levels.
Therefore, as investors there are lot fewer things to trouble yourself with, when you do cost averaging or SIP. Your only thing you have to think about is whether you can invest a fixed sum on a monthly basis.
There are two sides to every coin. Likewise there are advantages and disadvantages of SIP
Let’s understand SIP better with an example
|Date||NAV||Cash inflow/outflow||Units purchased/sold|
Referring the table above, an investment of Rs5000 is made in a particular fund on a regular basis at the beginning of each month in 2012, total investment sums up to Rs60,000 at various NAVs. The average NAV is 10.712
SIP helps you to buy units at an average price of 10.712.
As an investor you don’t have to infuse a lump sum amount in one go. SIP takes care of your monthly savings and it also works for you XIRR wise. It helps you purchase units at an average price and lowers the risk of buying units at a premium price.
There is not much difference between value and cost averaging. The only place where value averaging differs from cost averaging is
When you consider cost averaging, a fixed amount is invested on a regular basis, mostly monthly.
We will think of a lump-sum investment that follows value averaging.
Let’s assume Mrs Anand made an investment of Rs.5,00,000 in 2011 towards a which is due in 5 years. The required corpus after 5 years is Rs.8,00,000. This means the required rate of return is roughly 10%.
|Amount invested||Year||Investment Value @ 10%|
The above figures have to be met every year in order to achieve the set target
But let’s say that this doesn’t happen. We know that mutual fund investments do not have a fixed return rate like the fixed deposits
Expected rate of return on mutual fund investments vary unlike the fixed deposit. Rate of return on fixed deposit is well known in advance. Returns on fixed deposits do not fluctuate.
Value averaging investments focuses on having regular targets and also requires a regular check on the growth of investments.
Let’s look at the example below:
Example of Value Averaging
|Amount Invested||Year||Investment Value||Actual investment Value||Surplus/deficit|
|₹ 5,00,000.00||2011||₹ 5,50,000.00||₹ 5,30,000.00||-₹ 20,000.00|
|2012||₹ 6,05,000.00||₹ 6,00,000.00||-₹ 5,000.00|
|2013||₹ 6,65,500.00||₹ 7,30,000.00||₹ 64,500.00|
|2014||₹ 7,32,050.00||₹ 6,50,000.00||-₹ 82,050.00|
|2015||₹ 8,05,255.00||₹ 8,07,000.00||₹ 1,745.00|
In the above table, we add an assumption column- Actual Investment Value. This is the actual year-on-year progress of the investment amount and can be easily contrasted with the ideal investment value.
In the first year, expected growth of the portfolio should be at 10%, which will amount to 5.5 lakhs by the end of the year. But here the portfolio return isn’t upto the mark. It has a deficit of 20,000 than expected return.
Since there is negative figure, the amount should be added to the portfolio to achieve the target by the end of 5 years.
Value averaging basically tells us that the difference should be either invested or redeemed.
Assumptions of Value Averaging
Pros of Value Averaging
Cons of Value Averaging
Cost Averaging and Value Averaging are both work in their own ways.
Cost averaging makes work easier for someone who can invest a fixed sum on a regular basis, value averaging is for investors with surplus cash and alternative investment options.
In value averaging, possibility of reaching your goal is higher when compared to cost averaging. In cost averaging, fulfilling your goal depends on your investment returns when compared to expected return.
The best time to invest in equity is when the valuations are down and in debt when equity markets look expensive.