Rupee Cost

Technique & Benefits of Rupee Cost Averaging

Every investor has a common goal of maximizing returns over the long-term, and thus, they tend to adopt different investment instruments that help fetch returns. There are multiple avenues for investment, and therefore an investor must choose the one that allows them to generate high returns that beat inflation.

One of the investment avenues that is catching the fancy of investors these days is mutual fund. Mutual fund tends to perform well over the long-term and not only beat inflation but also helps in wealth creation. This is because mutual fund, when implemented in a disciplined manner, provide the benefit of compounding and meaning rupee cost averaging.

In this blog, Tarrakki – online mutual fund app seek to see rupee cost averaging technique, meaning and understand how it works and its benefits.

What is rupee cost averaging?

Rupee cost averaging is a concept that results in averaging out the cost of investment in a fund. Mutual fund, by nature, is volatile given their exposure to equities. Thus, an investor may invest in funds at a different price point. Rupee cost averaging is the technique by which an investor can average out his/her buying price in mutual funds.

Fundamentals behind rupee cost averaging

The underlying principle behind rupee cost averaging is – if an investor is disciplined in his approach of investing and continues to invest in the different market scenario, he/she ends up benefiting over the long-term as his cost of investment tends to average out over the long-term. Thus, commitment is what matters in this approach and frequency of investment and value of the investment may not play a significant role.

[ Also Check: Difference between SIP, STP and SWP ]

Mathematical Explanation of Rupee Cost Averaging Table

Assume that you started a Systematic Investment Plan (SIP) of Rs 2500 per month for one year. During the period of investment, the market has remained volatile, which has impacted the value of your fund. However, you decide to stay invested and continued with your SIP till the last month.

The following rupee cost averaging SIP table shows the investment for 12-months period, the price of the unit at which the investment is made, the units purchased and final profit.

Time
(in months)
Monthly investment (Rs) Price per unit
(Rs)
Units Purchased Cumulative units Portfolio value
(Rs)
Cost (Rs) Profit/ Loss (Rs)
1 2500 20 125.0 125.0 2500.0 2500 0.0
2 2500 21 119.0 244.0 5125.0 5000 125.0
3 2500 23 108.7 352.7 8113.1 7500 613.1
4 2500 25 100.0 452.7 11318.6 10000 1318.6
5 2500 19 131.6 584.3 11102.1 12500 -1397.9
6 2500 16 156.3 740.6 11849.2 15000 -3150.8
7 2500 14 178.6 919.1 12868.0 17500 -4632.0
8 2500 13 192.3 1111.5 14448.9 20000 -5551.1
9 2500 19 131.6 1243.0 23617.6 22500 1117.6
10 2500 22 113.6 1356.7 29846.7 25000 4846.7
11 2500 24 104.2 1460.8 35060.0 27500 7560.0
12 2500 26 96.2 1557.0 40481.7 30000 10481.7
Total 30000 19.63 1557.0   40481.7 30000 10481.7
Source: Tarrakki

If you see that your first investment had cost you Rs 20 and eventually the price of the unit increased and decreased, however, your disciplined approach of investing even during the bad times helped you average out the cost of investment to Rs 19.63 for the year. This has helped you accumulate a profit of Rs 10,481.7 at the end of the year.

[ Must Read – best investment of rs 10,000 in India ]

If you see, the portfolio returns were negative for four months (month 5 to month 8) during the year and despite negative returns, the year closed on a positive note due to committed approach.

Characteristics

  • The approach is best suited for investors who do not monitor or track the market regularly
  • The method is suitable for small investors (retail investors) who tend to remain disciplined in their manner of investing and can run the SIP for a long duration

How to get the benefit of rupee cost averaging?

To get the benefit of rupee cost averaging in SIP, an investor should adopt a disciplined approach to investing, also known as the SIP. A SIP allows an investor to get the advantage of averaging in an automated manner. Due to the disciplined approach under which the amount gets auto-debited from your bank account, the factor of volatility is reduced. This results in overall gain as we saw in the table above.

When to use rupee cost averaging?

The approach works best when the market is volatile and behaves erratically. Under this circumstance, an investor should adopt the SIP mode of investment and remain committed to the market irrespective of where the market is heading. It is seen that despite the choppy environment, the long-term equity investors have emerged out as successful investors.

Pros of Rupee Cost Averaging

  • An essential tool to generate maximum value for money invested in an unpredictable environment
  • An excellent tool for hedging if the movement of the market cannot be predicted
  • Requires less effort to track the market regularly
  • Flexible in execution
  • Offers opportunity for wealth creation over the long-term while providing the benefit of the down market
  • Inculcates the habit of regular investments
Conclusion

To conclude, we can say that rupee cost averaging is an essential tool for investors who are looking to participate in the equity market by way of mutual funds.

Given the current scenario of the economy, where the situation seems gloomy for the immediate short-term, the approach of averaging out the cost of investment by way of disciplined investing is fair as it will help the investor accumulate units at a cheaper rate. Doing this will enable an investor to collect sizeable wealth over the long-term, given the fact that India as an economy is likely to bounce back to its growth trajectory in the long-term period of a decade.

Should you wish to know more about the benefits of averaging out, feel free to connect with our experts by dropping in a line at info@tarrakki.com. To start your investment, install our Android & iOS application.

Until next time, happy investing. Mutual funds chuno, tarrakki karo!

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