Rupee cost averaging

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Rupee cost averaging is an approach in which you invest a fixed amount of money at regular intervals. This in turn ensures that you buy more shares of an investment when prices are low and less when they are high. By investing in a fixed schedule, you avoid the complex or even impossible duty of trying to figure out the exact best time to invest. The rupee cost averaging effect - averages out the costs of your units and hence lessens the results of short-term market fluctuation on your investments.

We often rely on our emotions, get swayed by market sentiments and end up buying when the markets are going higher and selling when they are lower. This is exactly what we should NOT be doing.

Rupee cost averaging helps us to minimize this guessing game. In the rupee cost averaging approach, you invest a fixed amount of money at regular intervals irrespective of whether the markets are going high or low. This ensures that you buy more units when the markets are low and lesser units when they are high. This approach brings down your average cost per unit over the long-term.

Systematic Investment Plans (SIPs) of mutual funds work on the rupee cost averaging approach.

Let's take an example. Priya invests a fixed amount of Rs 1,000 on the tenth of each month with a SIP in a mutual fund scheme. Let us see what happens in both the scenarios if the market goes higher or falls. Let us say she started investing in April and the market went up for 8 months.

Month

Amount invested each month

Price of each unit

No. of units accumulated

April

1000

15

66.66

May

1000

16.5

60.60

June

1000

18.3

54.64

July

1000

22

45.45

August

1000

24.6

40.65

September

1000

25

40

October

1000

28.1

35.59

November

1000

29

34.48

Total

Rs 8000

 

Rs 378.07

The average cost of buying each unit, in this case, comes at a much lower Rs 21.16 (total amount invested/total units accumulated).

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Similarly, if we assume that the markets fall during the 8 months, the average cost of each unit would come to Rs 20.05 (see the table below).

Month

Amount invested each month

Price of each unit

No. of units accumulated

April

1000

27

37.03

May

1000

25.5

39.21

June

1000

23

43.48

July

1000

21.6

46.29

August

1000

20.1

49.75

September

1000

18.5

54.05

October

1000

16

62.5

November

1000

15

66.67

Total

Rs 8000

 

Rs 398.98

In the second (market falling) scenario, if Priya would have invested Rs 8,000 as a lump sum in April itself at a NAV of Rs 27, then she would have got 296.29 units. These units by the end of 7 months would have brought down Priya's investment value to just Rs 4,444.35 (296.29 units multiplied by the price of each unit in November, i.e.Rs 15).

Comparing this to 398.98 units accumulated using the rupee cost averaging approach, her investment value in this case would be Rs 5,954.7. You can see the difference rupee cost averaging has made in cutting losses in Priya's investment.

While rupee cost averaging doesn't guarantee profits, it certainly demonstrates how a systematic approach to investing can prove highly effective in creating wealth over the long-term.

Wrapping up

Now that we understand the nitty-gritty of Rupee Cost Averaging, let’s learn about Algorithmic trading in the next chapter. 

A quick recap

  • The concept of rupee cost averaging lies in averaging out the cost at which you buy units of a mutual fund. 
  • Market volatility is part and parcel of equity investments, reflecting the ups and downs of the economy.
  • The law of demand says that a higher quantity of a commodity is purchased when it is least expensive. 
  • Conversely, the demand reduces when the price of the commodity increases.
  • The fundamental principle of investing reinforces the same thing. It guides the investor to “buy-low and sell-high”.
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