What is Rupee Cost Averaging and How Does It Benefit Investors?

Whether you’re a beginner or a seasoned investor, your portfolio is likely to have mutual fund investments. Mutual funds help you grow your wealth and achieve both short and long-term financial goals. However, market volatility can make you worry about the risk and rewards associated with your investments and restrict you from adding more funds. An effective strategy to maximize the returns from your mutual fund investments is Rupee Cost Averaging (RCA). It helps you stay disciplined without being swayed by short-term market fluctuations.

This article discusses what Rupee Cost Averaging is, how it works, its essence, its benefits, limitations, and more.

What is Rupee Cost Averaging (RCA)?

Rupee Cost Averaging (RCA) is an investment technique where a predetermined sum of money is invested at periodic intervals, irrespective of whether the market is rising or falling. This practice ensures that fewer units are purchased when the prices are higher and more units are obtained when the prices are lower. Over time, this process averages out the cost per unit, protecting investors from the impact of short-term volatility.

RCA doesn’t focus on timing the market. Instead, it allows you to invest consistently and avoid making emotion-led decisions. The strategy is especially effective when paired with Systematic Investment Plans (SIPs).

For instance, if you start an SIP of Rs 10,000 every month, here’s how the cost will average out in your portfolio over a period of 3 months.

While the unit price increased to Rs. 60 in August, the average per unit cost at the end of 3 months was Rs. 40. This is a benefit of periodic investing through RCA.

Additional Read: How to Invest in SIP 

How does Rupee Cost Averaging work?

Rupee Cost Averaging focuses on investing a fixed sum of money periodically with the discipline to eliminate the effects of market volatility over time. Here’s a step-by-step overview of the process:

1. Determine a fixed investment amount: Choose a fixed sum you can invest comfortably, such as Rs. 5,000 every month. 
2. Invest at regular intervals: Ensure you invest the predetermined amount periodically, such as monthly, quarterly, or annually, regardless of market prices. RCA is mostly done through an SIP in mutual funds.
3. Get units as per Net Asset Value (NAV): A fund’s NAV fluctuates based on market conditions. When the NAV is high, you get fewer units, but when the NAV is low, you get more units.
4. Cost averaging: Over time, the price per unit is averaged, reducing the effect of short-term volatility.
5. Remain consistent: RCA relies on the discipline of investing continually over the long term to build wealth steadily.

Advantages of Rupee Cost Averaging

1.     Lower average purchase price

Investing a lump sum in mutual funds does not allow you to spread your investments, and your average price remains the same as the purchase price. However, with the Rupee Cost Averaging approach, you buy more units when prices are low and fewer when prices are high. This results in a lower average purchase price over time, enhancing long-term returns.

2.     Protection against capital volatility

For smaller investors, high market volatility can lead to significant losses in just one trading session. The Rupee Cost Averaging method helps safeguard your capital from these risks. For instance, if there is a decline in the market, you can buy more units at a lower price. When the market rises, your profits increase too. This way, you don't have to worry about timing the market, making it a safer option during uncertain times.

3.     Affordable investment

SIP allows you to invest smaller, fixed amounts at regular intervals, making it budget-friendly. With the benefits of Rupee Cost Averaging, you don’t need to accumulate a large sum to start investing, making it accessible for individuals with varying income levels.

At the same time, since the risks are reduced with the Rupee Cost Averaging approach, you can even consider investing higher amounts after analysing the growth potential of your chosen funds.

4.     Hedge against inflation

Rupee Cost Averaging can act as a hedge against market fluctuations, reducing the risk of investing a large amount when prices are high. It ensures a disciplined investment strategy, helping you navigate through both bull and bear markets effectively.

5.    Avoid emotion-led decision-making

Emotions can significantly influence your investment decisions, particularly during market downturns. RCA enables you to control your emotions. It fosters the practice of investing systematically, regardless of the market’s direction. As a result, you don’t take impulsive decisions based on fear or greed. The strategy introduces automation in investing and reduces your need to guess appropriate market timing.

6.     Power of compounding with SIP

Rupee Cost Averaging is suitable for long-term wealth accumulation goals, including your child’s wedding or education, or retirement planning. Staying invested for a long time enables you to enjoy the power of compounding, and when combined with disciplined investing, it can grow your investments.

7.     Encourages long-term discipline

RCA makes you disciplined at investing. It encourages you to invest regularly over the long term, without being impacted by market fluctuations. Following a long-term approach, you can accumulate wealth consistently and achieve financial goals.

Limitations of Rupee Cost Averaging

The strategy of Rupee Cost Averaging has several benefits. However, it has limitations as well.

1.     Performs best in volatile markets

You can enjoy the benefits of Rupee Cost Averaging best when the markets are volatile, i.e., experiencing frequent movements. However, if the market is bullish, the strategy may not aid in earning good returns. Investing a lump sum when the market begins rising can work better.

2.     Does not promise profits or protection against loss

Rupee Cost Averaging can spread your investments to lower risks, but it cannot guarantee profits. If market performance is poor in the long term, you can suffer losses just like with any other investment strategy.

3.     Not suitable for lump-sum, short-term investments

Rupee Cost Averaging isn’t the right choice if you’re investing a large amount for quick profits. It is suitable for consistent, long-term investment. Those desiring to earn quick returns in the short term should not adopt the strategy. 

Understanding Rupee Cost Averaging with example

Suppose a person invests a fixed amount of Rs. 1,000 on the 10th of each month through SIP in a mutual fund scheme.

The investment’s performance will vary in a bullish and bearish market. Let’s see how.

Bull Market Scenario

In this case, the average cost of buying each unit is as low as Rs. 25.9 (total amount invested/total units accumulated).

Bear Market Scenario

In the bull market scenario, if a person invested Rs. 8,000 as a lump sum in April instead of SIP at a NAV of Rs. 27, then they would get 296.29 units. By the end of 7 months, these units would have brought down the investment value to Rs. 4,444.35 (296.29 units x price of each unit in November, which is Rs. 15).

In comparison, with the Rupee Cost Averaging approach, the individual was able to accumulate 398.98 units and the investment value turned out to be Rs. 5,984.7. [s2] 

Clearly, Rupee Cost Averaging has helped cut the losses on investment.

Rupee Cost Averaging vs Lump Sum Investment

The table below highlights the tangible distinction between the two, comparing the performance of an investment made via RCA and a lump sum.

• Lump-sum investment amount = Rs. 80,000
• RCA investment = Rs. 8,000 per month for 10 months

How to Get Started with Rupee Cost Averaging?

While RCA is a wise investment strategy against market volatility, it also requires some forethought.

• Choose a sum of money you can comfortably invest on a regular basis: This amount should ideally align with your financial goals and return expectations over a specific investment horizon.
• Select the instrument you want to stay invested in for a long time: Invest in a fund you’re confident will only see bullish trends in the future. However, if the fund performance has been consistently poor, redeem the shares to cut your losses. Only then can you tide over the fluctuations in unit prices and maximize gains in the long haul.

Additional Read: Why are SIPs an Ideal Choice for the First-time Investor?

Conclusion

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