Making Rupee Cost Averaging work for you

Making Rupee Cost Averaging work for you

In a marathon, participants are advised to go easy on sudden bursts of high speed during the race, especially at the beginning. This may sound like conservative advice and one may wonder how, without speed, can one cover and win such a long distance? However, it would be fruitless for the runner if he/she starts with a very high speed sprint and loses stamina mid-way.

Similarly, investors gain when they go steady with regular investments instead of looking at high speed sprints too often in the market. Investing modestly but regularly ensures that even in the worst of scenarios, the impact on your investments is relatively low and it rebounds when the market picks up. Experts suggest that you should buy when the markets are low and reap profit when they are high. How do you find out when the market hits its lowest or peaks in value? It is next to impossible to time the market accurately. Rupee Cost Averaging works to steer away this dilemma.

How rupee cost averaging works?

With rupee cost averaging, you can take advantage of the market highs and lows for your benefit. By making a fixed amount of investments every month through instruments like mutual funds, you can average out the value of each unit. Rupee cost averaging helps you buy more units when the market is low and less when the market is high, bringing down your average cost per unit.

Consider an example: Archana invests ₹10,000 each month in a SIP of an equity mutual fund. Say, the markets are volatile for a particular period. Her investments would look like below.

The average NAV cost per unit by rupee cost averaging comes lower to ₹99.6 (₹598/6) instead of ₹100 with 604.01 accumulated units. Further, if Archana does not choose the SIP method and would have made a lump sum investment instead, then her number of units in June would have been 600 (₹60,000/₹100) according to the NAV of June.

Now, let’s see the value of her investments, in both cases, 6 months down the line in November (NAV is ₹100). If she would have chosen the lump sum method, the value would have remained the same at ₹60,000 (600 units multiplied by NAV of November). On the other hand, with rupee cost averaging in the SIP method, the value would be ₹60,401 (₹604.01 multiplied by the NAV of November), which is higher than the lump sum option.

The SIP method of mutual funds works on the principle of rupee cost averaging. It helps mitigate the ‘timing’ factor and if you invest regularly, irrespective of the market level, it helps you earn higher potential returns.

Rupee cost averaging as a long-term strategy

It is important to understand that rupee cost averaging works well as a long-term strategy.

Consider, for example, Archana made her 6 purchases of the mutual fund’s units over the course of a month. While, the purchase price of the units may not be the same in any of the transactions, it is also unlikely that they will differ significantly over such a short time period.

On the other hand, over the long-term say 5 or 10 years, the price of a given unit is likely to change significantly. This is when rupee cost averaging really works to offer benefits. A SIP will leverage the benefits of rupee cost averaging in the long-term to ensure that your average cost per unit represents cycles of the market and averages out to an overall advantage.

Happy Investing

Source:hdfcmfinvestwise.com