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 scheme 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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