Value averaging

A systematic investment plan (SIP) invests the same amount at a fixed interval — say Rs 1,000 on the 25th of every month — whatever the market does. Because the amount is fixed, it buys more units when prices are low and fewer when they are high.

Value averaging goes a step further. Instead of fixing the amount invested, it fixes the value the investment should reach. Each period, it compares what the investment is actually worth with where it was supposed to be, and invests whatever closes the gap. The result, in the workbook's words: it puts more money in when the market is down and a lesser amount when it is high.

To do that, the plan needs one extra input that a SIP does not: an assumed growth rate for the investment.

The workbook example. Rs 10,000 is invested each month, with an assumed growth rate of 1% a month for simplicity.

• Month 1. Both the SIP and the value averaging plan invest Rs 10,000. At 1% growth, the investment is supposed to be worth Rs 10,100 at the end of the month.
• Month 2, market down. The actual value is Rs 9,900. The shortfall against the Rs 10,100 target is Rs 200, so the plan invests Rs 10,200. The SIP invests Rs 10,000.
• Month 2, market up. The actual value is Rs 10,400. That is Rs 300 more than the target, so the plan invests only Rs 9,700. The SIP still invests Rs 10,000.

This automatically ensures that the investment is more when prices are down and less when prices are up.

The two challenges the workbook names:

1. Complexity — as the number of instalments increases, the calculations can get pretty complicated.
2. Product constraints — mutual funds do not allow this kind of change every month in a normal SIP, so the investor has to manage the difference in their own way, which can prove to be very tough.

The workaround: some AMCs offer products that increase or decrease the quantum of SIP as per market levels, which are easy on the investor.

Investment this period = Regular amount + (Target value − Actual value)

Workbook, month 2:
  Market down: 10,000 + (10,100 − 9,900)  = 10,200
  Market up:   10,000 + (10,100 − 10,400) =  9,700

The investment amounts are the workbook's; the NAVs are assumed to show the effect on units.

Suppose the fund's NAV was Rs 100 when the first Rs 10,000 went in (100 units). The month-end values in the workbook then correspond to NAVs of Rs 99 (value Rs 9,900) and Rs 104 (value Rs 10,400).

In the falling month, value averaging buys 2.02 more units than the SIP at the lower price. In the rising month, it buys 2.88 fewer units at the higher price. The SIP already tilts purchases towards cheap units because its amount is fixed; value averaging tilts them further by changing the amount too.

The practical problem shows up immediately. The investor's month-2 cheque is either Rs 10,200 or Rs 9,700, and a normal SIP mandate cannot vary it. In a sharp fall the shortfall — and so the required top-up — could be many times Rs 200. An adviser recommending the approach must confirm the client has the spare cash for the down months, or use a product from an AMC that varies the SIP amount by market level.

Chapter 11 (Mutual Fund), section 11.9.5 — Value Averaging Investment Plan — among the systematic transaction facilities of 11.9. Expect a computation using the workbook's pattern (target value, actual value, investment needed) and a conceptual question on how it differs from a SIP and what its practical limitations are.

• A SIP fixes the amount; value averaging fixes the target value and varies the amount.
• Below target → invest more; above target → invest less. Reversing that is the most common error.
• An assumed growth rate is required — the workbook uses 1% a month.
• Month 1 is identical for a SIP and value averaging; the figures diverge from month 2.
• Normal mutual fund SIPs do not allow monthly changes in amount. The investor has to handle the difference, unless an AMC product varies the SIP by market level.
• Its limitations are complexity and practicality, not that it buys more when prices are high — it does the opposite.