How to make more money when markets are volatile

Apart from SIPs and STPs, value-averaging can help investors make more money, says Devangshu Datta.

The Systematic Investment Plan (SIP) is popular and practical for anybody with periodic savings.

It is a good way to invest in volatile assets such as equity, exchange traded funds, equity mutual funds (MFs) and debt-MFs.

If prices fall, an SIP automatically averages down the price of acquisition, making it a hedge.

This ensures the investor is poised to make greater profits eventually when the market cycle turns.

An SIP is less effective when prices rise. But then the investor is making a profit anyway.

A variation is the systematic transfer plan (STP) where the investor transfers holdings from one asset to another.

This may consist of a systematic liquidation of some debt holding, using the proceeds for an SIP into equity. Or it can be the reverse process.

An STP works well if the investor has a lump sum, which can be parked in a debt instrument and gradually deployed to equity.

The SIP commonly employs EMIs or equal monthly instalments. This is 'currency averaging' or rupee cost averaging.

Another method is value averaging. This is more complex.

In value averaging, the investor targets a growth in value by the same amount every month. This implies selling under some circumstances.

For example, say, the investor wants the portfolio value to grow by Rs 1,000 a month.

In the first month, he buys Rs 1,000 worth of units, which are priced at Rs 10.

Say, the unit value depreciates by 10 per cent. Then, in second month, he buys Rs 1,100 of units.

The price rises by 10 per cent, and he buys Rs 800 in the third month.

Then the price rises by 20 per cent. In the fourth month, he buys only Rs 400 worth of units.

The price rises by another 20 percent and in the fifth month, he buys only Rs 200 worth.

Then the price zooms by 30 per cent and in the sixth month, the value-average is holding a portfolio worth Rs 6,500.

This time, he sells Rs 500 worth of units.

This stylised example shows how value averaging works.

At the end of this six month period, the value-average has invested net Rs 3,000 and holds 300 units valued at Rs 6,000.

In contrast, a normal EMI SIP would invest Rs 6,000 and the EMI holder would own 517 units worth Rs 9,685.

• MONEY TIPS

The IRR (internal rate of return) is higher for the value-average and value averaging also has some practical advantages.

It enables the investor to target holding exactly Rs X at the end of a given period.

So, it can be used to park money in a volatile asset like equity to settle a loan principal, or some other fixed expense.

This example is given for a rising market. But one disadvantage for value-averaging is that it requires larger sums to be invested when prices are falling.

See the investment in the second month, for example.

Of course, this means the value-average also buys more units in bear markets and thus, stands to gain even more when the market turns bullish.

Most investors find value-averaging a tedious process and stick to SIPs, or just buy in lump sums.

In a sustained bull run like the current one, where price have risen over 40 per cent in 15 months, value-averaging systems have edged close to 'zero-buy' or to sell mode.

This is the other advantage of value-averaging; it reduces equity exposure in a very bullish market.

Value-averaging systems can also be tied to 'reverse STPs', where equity profits are being booked and transferred to debt funds. If the Reserve Bank of India does cut rates that could be a good strategy.

Illustration: Uttam Ghosh/Rediff.com