Sindhu wrote in about a month ago inquiring about ICICI Direct’s Target Investment Plan (TIP) scheme and if it’s any better than the systematic investment plans that you normally have at other brokers, and of course ICICI Direct as well.
The way the Target Investment Plan works is that instead of specifying a fixed amount that will be used to buy mutual funds every month – you specify a target, a rate of return, and time frame in which you want to get to that target.
The TIP system will then alter your monthly contributions based on the current value of your portfolio. The example in the PDF that I’ve linked to above explains the mechanics quite nicely, so I’m going to use the same example here.
Suppose, you want to have a sum of Rs. 10 lacs after 7 years, and you decide on an expected rate of return of 12%. If this rate were to be uniform throughout the 7 years – you will have to invest Rs. 7,700 every month.
However, equity investments are inherently volatile and say at the end of the first month – you find that your first installment of Rs. 7,700 is only worth Rs. 7,000 now. The system will recalculate your next installment to find out what amount is needed now to reach your goal. In this case it is Rs. 8,400, so they will deduct that from your account and invest it in your mutual funds.
Similarly, if the portfolio value gains then they will reduce your installment with the newly calculated sum and use only that much money to buy your mutual funds.
This is an interesting concept, and I think you could do one of these in addition to your SIPs but I won’t be in favor of getting rid of SIPs altogether for this.
One reason for that is if the system determines that you are ahead of your target and reduces your mutual fund investments, then what happens to the cash that is spare – are you vigilant enough to invest it yourself in other equities or are you going to invest it in fixed debt instruments or will it just lie there in your savings account?
The second reason is that this system will add a layer of complexity to your investment process because I don’t think it’s possible to correctly ascertain how much money will be needed in the coming month especially with how volatile the stock market can get. So, that’s one more thing you have to keep track of.
The third reason is that while you can cancel the TIP – you can’t modify it so if you find out midway that you want to invest more or reduce your target then you will have to find another avenue to do that.
The fourth reason is that the success of this system is more or less to do with timing the market and as we know that doesn’t work very well most of the time. If it would, then you’d see mutual funds that make buy decisions based on P/E multiples do better than every other class of funds.
The fifth reason is that it’s a relatively new product, and you don’t want to put all your money in this without trying it out for some time and seeing how it works for you.
These were product specific thoughts, but if you look at this at a slightly higher level you’d see that what you want to achieve with this product is to invest more of your money in equities when the market is low (like it is today) and pull back from them when the market is high.
There is nothing that stops you from doing this yourself – if you have a few SIPs going – you can invest additional sums yourself when the markets are low – and the lack of a system is not preventing you from doing it.
It’s the uncertainty that surrounds the market when it’s down that prevents you from doing it, and that’s why you see people stop their SIPs or sell their stocks at a loss in times such as today. To that extent, this product will not be able to help you help yourself, and that’s something that you will have to overcome yourself.
In summary, I think this can be a useful product and can be tried out in addition to SIPs by choosing reasonably small targets over a shorter time frame to start with, but I wouldn’t go as far as to replace SIPs with them.
To all the skeptics, how about some statistical analysis for you?
http://www.academyfinancial.org/09Conference/09Proceedings/%286C%29%20Chen,%20Estes.pdf
If any company comes up with proper value averaging tool, I will definitely go for that.
But their Value Averaging plan talks of a core bond portfolio and a growth equity portfolio and moving money from the bond portfolio to the equity portfolio and vice versa based on the market conditions. However, this plan doesn’t have any bond component, just an equity component so it is markedly different, is it not?
It is slightly different from your understanding. The core is still that growth equity fund and the analysis is still doing value averaging.
However, the only difference is the pool from where the money is drawn and invested in the equity portfolio. In case of ICICI it is cash from your bank account. In case of the analysis it is a bond fund.
And there is no market timing, just achieving fixed 12% return every year by either putting money into the equity from bond (when market is down) or redeeming some amount from equity to bond (when market gives you more than 12% return). It’s all mechanical.
And why bond and not cash? when equity is redeemed, the excess money earns better return than bank account till you tap into the fund again in the down market.
How much will that make any difference? I don’t know. But given that you would be constantly taking money in and out of the bond fund, you are not going to have much corpus in it anyway.
BTW, such options do exist in Indian broker market although in slightly different shape and form.
Agree with bemoneyaware, above: things are being made waaaaay too complicated.
Any investor will also need nerves of steel when they see more and more of their cash being taken out as a contribution every month, when the funds are showing negative returns for extended periods. Add to this the “crowd” effect: other unit holders also pull their money out of the fund at the bottom of the market, causing the fund to have to sell underlying investments at a bad time to be able to meet their liquidity needs from people withdrawing. This will send the returns of the fund even lower, leaving the investors with a long-term view holding the proverbial garbage bag.
Definitely not for the faint of heart. Nice article, Manshu!
I clicked through to your blog and was amazed to see that you run a PF blog on South Africa! Welcome to OneMint, and I’ll be curious to hear how you found the site :- )
Interesting product. However, it can give jitters to some people if the monthly installment amount suddenly goes up.
The Target Investment Plan give you the assurance of reaching the target but at what cost?
Whenever markets go down you are forced to invest more to compensate for the loss.
In otherwords when markets are bad you are forced to save and invest more and compensate for the loss to reach the target. This can work only provided its a small part of your overall portfolio. If you solely rely on this scheme, you may be forced to shell out more when the markets are bad.
Dont try to apply the laws of mathematics and concepts of optimization, maximization, etc to investing. These structured models may not work. Flexibility is more important than having a nice formula or target. In fact if you have a target in mind, do an SIP plus some do some additional savings as a back-up to cushion for losses or unexpected events. The savings can be in cash or in debt instruments or fixed deposits.
The whole point of this product is that more money will be invested when markets are down, so people who invest in it should understand that and view it as a feature not a bug.
Very nice article Manshu.
Thanks Ams!
Quoting from article Keep it simple by Dhirendra Kumar,CEO of valueresearchonline.com .
One of the worst things that the financial services industry does is to regularly take simple and effective idea and then complicate it beyond the point of usefulness. India’s mutual fund industry is currently busy doing this to SIPs.
There are suddenly a whole host of modified SIPs being offered by AMCs (and some distributors too), that add what is basically an element of market-timing to SIPs
Bottom line: As an investor, you should steer clear of all the complexity of these market-timing SIPs. They just complicate the decision-making process.
Another article from economic times Can tweaking your SIP give you the edge? which states Ultimately, the only way to create serious wealth is through disciplined investing
I’m not surprised by that assessment, and it sounds fairly reasonable as well. However, I’m also of the opinion that any new product is met with skepticism first, and that’s just human nature.
To me, an interesting way to approach this would be to think what if TIPs were always in existence, and then someone came up with SIPs – what would the general reaction be then?
Isn’t this the same as Value Investment Plan, that Benchmark mutual fund (now Goldman Sachs) introduced around 3 years back?
Oh yeah – that’s absolutely right – I didn’t think of it at all but that was like this too.