A term that is hard to miss when one reads about equity or mutual fund investment, the rupee cost averaging is an approach that is often recommended for those who are new to the market. Lacking the requisite expertise and knowledge of tracking the market meticulously, one can choose to go through the Systematic Investment Plan (SIP) route and benefit from the use of the rupee cost averaging method.
What is Rupee Cost Averaging?
Rupee cost averaging means systematically investing a specific sum of money at specific intervals. By doing so, the investor gets to purchase more units when the prices are low and a lower quantity of units when the prices are high, reinforcing the fundamental principle of investing i.e. buy-low and sell-high. It is the opposite of a lump sum investment.
In order to understand how the investor really benefits out of this, one may look into the example given below.
Hasina invests in an SIP plan to augment her financial portfolio. She decides to put in a sum of Rs. 2,000 every month for a period of 6 months. Her SIPs look something like this –
|Time||SIP Amount||Price per unit||Number of shares allotted|
|January 2021||Rs. 4000||80||50|
|February 2021||Rs. 4000||96||41.67|
|March 2021||Rs. 4000||84||47.62|
|April 2021||Rs. 4000||68||58.82|
|May 2021||Rs. 4000||56||71.42|
|June 2021||Rs. 4000||60||66.67|
The total investment is Rs. 24,000 and the total number of shares is 336.20. The average price per share would amount to Rs. 71.38.
Let us look at another example. Rocky wishes to invest Rs. 10,000 in a fund with the following NAVs – NAVs: Rs 200, 250, 150, 100 and 300 and gets allotted 50, 40, 66.66, 100 and 33.33 units respectively. The total invested amount is Rs 50,000 and the total number of units over the 5 investment periods is 289.99. The average NAV or price per unit works out to be Rs 172.41, which is less than three of the five NAVs that Rocky bought into the fund.
When is Rupee Cost Averaging useful?
The rupee cost average is useful in the following situations –
- When the investor does not have a specific sum of investment ready.
- When the investors wish to build a fund and invest some money for a future date.
- When the investor wishes to invest a constant amount in a specific stock of a particular portfolio on a continuous basis.
Uses of Rupee Cost Averaging
- This method works out best in choppy markets but is useful when the market is bullish too.
- In dividend reinvestment plans, which are a type of mutual fund, the amount is calculated with the help of rupee cost averaging which enables one to select a specific amount at which one can go ahead and buy a stock over a particular period of time.
- It can be used while investing in cryptocurrencies too. It helps the investor purchase a fixed quantity of cryptocurrencies at regular intervals, with minimal effort.
- When one invests in equity mutual funds, then the use of rupee cost averaging acts as a cushion against market volatility.
Benefits of Rupee Cost Averaging Method
- In the presence of a fixed schedule, one needn’t explore the ‘right time’ to invest. It minimises the guessing.
- It also prevents beginners from investing based on predictions of “all-time market low” or “all-time market high” which are merely speculations with little guarantee.
- This approach averages out the costs of the units lessening the impact of short-term market fluctuations on one’s investment.
- The average cost of investment will be lesser than the average market price.
- It does not guarantee profits but it is an effective way of creating wealth over the long run.
- It enables the investor to be aware of his or her financial commitments on a monthly basis and make decisions accordingly.
Investing in SIP using the rupee cost averaging method helps create both financial and psychological discipline in the investor. It helps him or her automate the entire process, minimizes speculations regarding when to invest and also delinks sentiment from investing. The returns that are achieved through such means are better for they are achieved with lesser effort and more discipline.
Frequently Asked Questions
- What are the two main strategies to invest?
One can invest his or her money as a lump sum or systematically.
- What is the most important benefit of rupee cost averaging?
The most important benefit is that it helps the investor manage market volatility effectively through financial and psychological discipline in investing.
- What are the limitations of Rupee Cost Averaging?
It is a strategy for buying and not for selling.
- The intervals between each purchase are not indicated.
- Only when the markets and the stocks work in a cyclical fashion, does this method find its proper application. For instance, if the stocks only show a downward trend, then this method will bring no profit to the investor.