Rupee Cost Averaging: Meaning, Benefits, Formula & Examples

Could you imagine scoring a “gold mine" when the market is falling? Well, you’re in for a surprise! 

It is common to swing between fear and greed during drastic market corrections/volatility, whether you're a seasoned player or not. However, like most investors, you're probably more anxious about buying the units at the "wrong" time.

Sure, you can try to time the market. But how can you figure out the market conditions correctly? Well, the truth is: you cannot. This is where Rupee Cost Averaging (RCA) can take away the guesswork for you.

What Is the Rupee Cost Averaging In SIP?

RCA is a systematic investment approach wherein you invest a fixed sum at regular intervals to purchase a particular instrument's shares, say equity mutual funds, irrespective of the unit price or market condition. The age-old wisdom of “buying low” is actually at play here. During bearish runs, when funds have hit the lowest price points, you buy more units. And when bulls are dominating and prices are soaring, you buy fewer units. 

As a result, you end up owning a fund unit at a much lower cost than the market average. It reduces the impact of market movements on your portfolio and brings down the overall investment risk. This is also how a Systematic Investment Plan (SIP) functions.

Case in point: say you started investing in equities every month via a SIP of Rs. 10,000. Here's how your portfolio will pan out over the course of 10 months.

As you can see, your average cost per unit was Rs. 40 at the end of August when the market price was Rs. 60. Also, compare the final value of your investment, i.e., Rs. 54,999.6 (916.66*60) to your total investment of Rs. 30,000 – resulting in a profit of Rs. 25,000.

Other key advantages of RCA:

• Make the most of market dips
• Maximise profits over long-term
• Avoid impulsive decisions
• Doesn’t require frequent portfolio tracking
• Works as a hedge against falling markets
• Most importantly, peace of mind!

Additional Read: How to Invest in SIP 

Advantages of Rupee Cost Averaging

1. Lower average purchase price

Investing a lumpsum 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.

How Does The Rupee Cost Averaging Work?

Rupee cost averaging involves investing a fixed amount in a mutual fund regularly, regardless of market conditions. 

When the fund NAV is low, your fixed amount buys more units and when the NAV rises, it buys fewer. Over time, this method reduces the overall cost of your investments by averaging out the purchase price. This strategy is often used in mutual fund investments, particularly in systematic investment plans (SIPs), as it takes advantage of market fluctuations to balance risk. 

It encourages disciplined investing, making it easier for individuals to manage long-term investments without the stress of market timing.

Understanding Rupee Cost Averaging With Example

Let's take an 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. 

Let’s understand how the investment will be, if the market goes higher or falls. Consider that the person started investing in April of a particular year and the market went for 6 months.

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

Similarly, let’s assume that the markets fall during the 6 months, the average cost of each unit would come to Rs. 29.65-

In the market falling scenario, if the person invested Rs. 8,000 as 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. 

Clearly, rupee cost averaging as helped cut the losses on investment.

How to get started? 

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

1. 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. 
2. 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 you can tide over the fluctuations in unit prices and maximise gains in the long haul. 

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

Bottom line 

Think it's time to switch your MF investment strategy? Consider Tata Capital's Moneyfy app, a digital solution to meet your investment needs under one roof. Now benefit from personalised fund recommendations aligned to your risk appetite, compare funds across categories, and seize the opportunity on time!

FAQs

What is criticism of rupee cost averaging?

A drawback of rupee cost averaging is that it might limit potential gains in a consistently rising market. Investors may miss out on opportunities to buy in large amounts when prices are low.

What idea is used in rupee cost averaging?

Rupee cost averaging is based on the idea of investing a fixed amount regularly, regardless of market fluctuations. This involves buying more units when prices are low and fewer when prices are high.

How does rupee cost averaging help a mutual fund investor?

Rupee cost averaging helps mutual fund investors by spreading their investment over time, reducing the impact of market volatility, and lowering the risk of buying units at high prices, thereby potentially increasing returns over time.