Concepts Demystified-SIP : Rupee-Cost Averaging

How often have you asked yourself, “Is this the right time to invest?”

How often have you been caught in situations where you feel that you have entered the market too late or exited too early? How often have you redeemed only to see the markets go up or worse just invested and have had markets crash?

Rather than agonizing over the answer time and again, you may want to consider an investment strategy that eliminates trying to outguess the market, and instead takes advantage of market highs and lows to your advantage – Rupee-Cost Averaging.

 

mutualfundWhat is Rupee-Cost Averaging?

Simply put, Rupee-Cost Averaging is committing a fixed amount of money at regular intervals to an investment such as a mutual fund, which enables you to average your cost over a period of time. There’s an intrinsic logic to this technique. You can buy more units when prices are low and fewer units when prices are high.

How does it work?

The only thing certain about investing is uncertainty. Stock and bond prices will fluctuate – day to day, month to month, and year to year. With Rupee-Cost Averaging, your money always buys fewer units when markets are up and more when they are down.

Let’s say for example, that you invested Rs. 1000 every month for six months – during a period of fluctuating prices. The table below illustrates how your average unit cost could be less that the average price per unit during that period.

ab1-300x114

 

Average price (NAV): 50/5 = Rs. 10.00 Your average cost: Your total investment / total no. of units: 5000/508.333= Rs. 9.84

Lump Sum Investments vs. Rupee-Cost Averaging

Let’s assume you invested Rs. 5000 in a lump sum at the start of Month 1 when the NAV was Rs.10. You would have been allotted 500 units. After the rise and fall in NAV, at the end of Month 5, your investment would still be worth Rs.5000 (at the last NAV of Rs.10). As opposed to this, had you invested Rs.1000 regularly for 5 months, the value of your investment would have risen to Rs.5083 (=508.33 x 10), a gain of Rs.83 over the lump sum investment. This is due to the lower average cost and therefore, the higher number of units accumulated in case of Rupee-Cost Averaging, viz. 508.33 at the average cost of Rs.9.84.

Systematic Investment Plan: A great way to take advantage of Rupee Cost Averaging

A Systematic Investment Plan (SIP) facility offered by mutual funds effectively puts Rupee-Cost Averaging technique to use and should be used in order to mitigate the risk of the ‘rise and fall in the market’ to a certain extent. Keep in mind that Rupee-Cost Averaging usually works best over long periods of time, so you must have the resolve to continue contributing on each scheduled date, even during an extended down market.