Mumbai: I know a security guard who allocated money from his salary to invest it through rupee cost averaging. He has not skipped a single payment for the past five years. And, he has increased the amount twice and has not even murmured during the drop from 21000 to 8000.
What’s rupee cost averaging?
Rupee cost averaging is a series of equal rupee investments made at regular intervals. Simple put, it is the Systematic Investment Plan (SIP) method of investing.
Rupee cost averaging is a simple strategy that can be used by investment experts as well as novices. Instead of investing lump sum at one go, you invest equal amounts at regular intervals over a period of time.
How does it help?
It lowers your purchase price. Let’s assume you want to invest Rs 50,000 into an index fund with Rs 50 net asset value (NAV) at the beginning of the year. You would have purchased 1000 shares.
On the other hand, let’s say you spread those purchases out in Rs 4,170 monthly payments. And, let’s say that index has been fluctuating over the course of the year with a range of Rs 41 to Rs 57. How will your portfolio work in such as case?
Here’s how:
NAV
Units purchased
1
4170
50
83.3
2
4170
44
94.7
3
4170
41
101.6
4
4170
41
101.6
5
4170
44
94.7
6
4170
50
83.3
7
4170
56
74.4
8
4170
50
83.3
9
4170
41
101.6
10
4170
50
83.3
11
4170
56
74.4
12
4170
57
73.1
Total
50,000
1049.5
Result: Because of cost averaging strategy, you could purchase more shares during the same period with the same investment amount, inspite of the swinging volatility.
Rupee cost averaging reduces the risk of buying your investment at its highest point. By making multiple purchases, you’re bringing your average cost per share down.
Where do I begin?
Step 1: Start with a consistent amount (most of them allow transactions as small as Rs 500).
Step 2: Set up a regular investment schedule
Believe it or not, it’s as simple as that. For those who are investing for the first time, this is the best way to begin. For all those experienced investors looking to get back into the market, it’s the perfect way to rebuild.
The dark side of rupee cost averaging
There are some limitations to rupee cost averaging. As a strategy, rupee cost averaging works best in mixed, uneven or choppy markets. There could be two situations where you might want to question an SIP:
Situation 1: If the markets were going into a sharp downturn, the best strategy would be to wait as long as possible before getting back in.
Situation 2: If the market was going to move straight up, you would want to put all of your money in as quickly as possible.
However, the fact of the matter is that no one can time the market. So as intelligent investors, we need to choose a strategy that will allow us to maximise our returns. It’s why rupee cost averaging is so flexible and appropriate for the market conditions right now. Remember, the net result is that your average cost should equal the average price during that period.
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