Intermediate

WHAT IS RUPEE COST AVERAGING? HOW DOES IT HELP YOU?

Age old wisdom dictates that you invest your money when the market is low, so that you can earn returns when it starts rising. But entering the stock markets at the lowest possible levels is an instinctive wish of most investors. When stock prices decline, investors should ideally be tempted to purchase their favorite shares and mutual funds. However, often, the temptation is accompanied by the expectation of further decline in prices, which makes investors wait longer. The prolonged wait usually results in inaction and by the time the markets rebound, the wait seems futile. Then there is also another large portion of investors who get emotionally impacted by falling markets and end up not wanting to invest at all as the fall in their invested value paralyzes them. Volatile times cause difficulty in effective investment decision making.

Timing the market accurately is a difficult task which is rarely accomplished on a consistent basis. However, the good thing is that you don’t need to have a crystal ball to earn profits. We’ve got a substitute for you. Introducing Rupee Cost Averaging. This refers to investing fixed sums of money regularly in a particular mutual fund schemes at different points of time and hence, at different NAVs. What automatically ends up happening is that you buy more units at a lesser price and less units when the price goes higher. This results in the average cost of your investment per unit being lower than the average NAV per unit over time. This is one of the most reliable ways to gain from market volatility.

A great way to harness this strategy is through the Systematic Investment Plans (SIPs) facility offered by mutual funds. SIPs are a great way to reduce the average cost of your investment, which in turn, increases the scope of potential gains.

Consider the following example to understand the benefit of Rupee Cost Averaging vis-à-vis investing through SIP or a lump sum amount at a single point of time.

Case 1: Let’s say you invest Rs 2,000 each month through a SIP in equity mutual funds:

Year 2014 (Month) Investment Amount Net Asset Value of the Fund Equity Mutual Fund Units  
Jan Rs 2,000 Rs 20 100 Rs 2,000
Feb Rs 2,000 Rs 17 117.64 Rs 3,700
Mar Rs 2,000 Rs 19 105.26 Rs 6,135
Apr Rs 2,000 Rs 18 111.11 Rs 7,812
May Rs 2,000 Rs 15 133.33 Rs 8,510
Jun Rs 2,000 Rs 16 125 Rs 11,077
Jul Rs 2,000 Rs 17 117.64 Rs 13,770
Aug Rs 2,000 Rs 18 111.11 Rs 16,580
Sep Rs 2,000 Rs 19 105.26 Rs 19,501
Oct Rs 2,000 Rs 17 117.64 Rs 19,448
Nov Rs 2,000 Rs 18 111.11 Rs 22,592
Dec Rs 2,000 Rs 22 90.90 Rs 29,612
  Total = Rs 24,000   Total = 1,346  
Total = 1,346

Case 2: When you invest Rs 24,000 with a one time, lump sum investment:

Year 2014 (Month) Investment Amount Net Asset Value of the Fund Equity Mutual Fund Units Investment Value
Jan Rs 24,000 Rs 20 1,200 Rs 24,000
Feb - Rs 17 - Rs 20,400
Mar - Rs 19 - Rs 22,800
Apr  - Rs 18 - Rs 21,600
May  - Rs 15 - Rs 18,000
Jun  - Rs 16 - Rs 19,200
Jul  - Rs 17 - Rs 20,400
Aug  - Rs 18 - Rs 21,600
Sep  - Rs 19 - Rs 22,800
Oct  - Rs 17 - Rs 20,400
Nov  - Rs 18 - Rs 21,600
Dec  - Rs 22 - Rs 26,400
  Total = Rs 24,000   Total = 1,200  
Average Cost of Investment = Rs 20 per unit
Total mutual funds bought = 1,200
Final value of your investments = Rs 26,400

From the example above, it is evident that a systematic investment plan is more rewarding in volatile times than lump sum investment not only due to the ability to generate higher returns, but also due to the effect of Rupee Cost Averaging- which lowers your average cost of investment per unit. You can thus avoid the trouble of waiting for the best possible time, or finding the lowest possible levels to invest in the markets.

To summarize, Rupee Cost Averaging implemented through a systematic investment plan enables you to manage market volatility very effectively. However, it should not be taken as a guarantee to earn profits as all equity-oriented investments are subject to market risk. To ensure that you gain the most from Rupee Cost Averaging and SIPs, you need to invest continuously over the long term.

Consult your investment advisor to know more on Rupee Cost Averaging.

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Key Takaways

  1. Rupee cost averaging implies investing a fixed amount consistently over a long period of time in a particular investment which results in the average cost of your investment being lower than the average market price.

  2. Rupee cost averaging can be easily applied through Systematic Investment Plans (SIPs) offered by mutual funds.

  3. SIP helps lower the cost of your investment over the long term by automatically purchasing more units when the prices are low and fewer units when the prices are high.

  4. Rupee Cost Averaging helps you to manage market volatility in an advantageous manner.

  5. To benefit the most from systematic investment plans, you need to invest regularly over the long term.