What is Rupee Cost Averaging?

24 Mar 2022  Read 1257 Views

Capital appreciation and wealth creation is an art but not everyone is an artist 😛. The silver lining in the cloud is, you can master the art of investing by continuous learning.  

Today we bring one such stock market concept for you to understand and that is Rupee Cost Averaging. You can apply this concept through mutual fund investments or by directly investing in stocks. 

So, without waiting any further let us dive into the topic for the day. 

What is Rupee Cost Averaging

Rupee cost averaging is a strategy to avail the benefits of volatility in the market.

A certain amount of money is invested at regular intervals to avoid or minimize the risk of a one-time lumpsum investment. This way, the investor at the end of the investment period becomes the owner of more units at an average price, eliminating the possibility of timing the market correctly and hedging the investment from market volatility.

The advantages of spreading the money are such that it fulfils the basic rule of investing that encourages an investor to buy at an undervalued price and maximize the long-term profit.

There are various ways by which the benefit of Rupee cost averaging is achieved and one of them is through mutual fund investments in the form of a Systematic Investment Plan which is also popularly known as SIP. This plan of action is most suitable for retail investors who have less time and knowledge to monitor the market regularly.

The strategy showcases the best result with long-time investment with patience where regularly funds are appreciated irrespective of what the unit price is because eventually, it will come down to an average price at the end of the investment period.

Moving forward, let us see how do rupees cost averaging works. 

How Does Rupee Cost Averaging work? 

So, how does the concept work? Let's take a look at the table below to understand how averaging works in the case of SIP investment.

Months

Amount Invested

Unit Price

No.of units bought 

Jan

5000

35

142.8571

Feb

5000

32

156.25

March

5000

30

166.6667

April

5000

36

138.8889

May

5000

34

147.0588

June

5000

29

172.4138

July

5000

28

178.5714

August

5000

27.8

179.8561

September

5000

34

147.0588

October

5000

34

147.0588

November

5000

34.1

146.6276

December

5000

30

166.6667

TOTAL

60000

383.9

1889.975

In the table, it is visible how every month on a particular date a fixed amount of sum is invested at the different unit prices, some prices being higher or lower than the previous one. 

Eventually, at the end of the fourth month, the investor receives a total of 1889.9 units from his Rs. 60,000 investment at an average price of 31.74 (60000/1889.975).

However, in a real-time market, this investment should be for a longer period for maximum return at the best price.

Rupee-cost averaging is one of the easiest and most basic tools an investor can follow to safeguard their investments. It saves a lot of analysing time, gives the benefit of investments in every cycle of the market, is disciplined and eventually brings your investment in a good averaged price with decent units in funds. Let’s discuss these advantages in detail below.

Importance of Rupee Cost Averaging

Beats the Market Volatility

We all know that the stock market can be very volatile and this makes investing even riskier. Since under Rupee cost averaging your investment is averaged out, this factor hedges the investment against market volatility. 

Just in our example above, the invested amount was ₹5000, but the unit price changed at every level from the levels of 35 to 38, depicting the volatility in the market. But still, due to investing at every level, the average price becomes ₹31.74. Thus, it is evident that Rupee cost averaging helps hedge the investment. 

A flexible option

Averaging is a flexible option if done in equities. And by equities, we mean that if you are not investing through mutual funds but directly in ideal stocks of your choice, then averaging becomes flexible as you are not bound to invest a particular amount every  month. Still, it's up to you when do you want to invest. 

Let’s understand this with an example.

Suppose you bought 100 shares of Reliance Industries at ₹2000. Six months later, the stock price of Reliance Industries becomes ₹1500 then you can buy additional 100 shares, and your investment price will become  ₹1750 for 200 shares. 

Long term benefits

Rupee cost averaging provides long term benefits to the investor in the sense that it lets them stay invested for a longer period of time to avail the benefits of averaging.

A disciplinary effort

Investment done through a systematic plan forms a disciplinary effort as each month a fixed amount is invested.

Benefits of Average price

Last but not least. Rupee cost averaging provides an average price at the end of the investment period. 

Just take a look at the example above. The unit price fluctuated at every level. But at the end of the investment period i.e after 12 months, the investor arrived at an average price of 31.74. Thus, the most significant benefit that Rupee cost averaging provides is obviously Averaging. 

Still, there are drawbacks to this concept which will be discussed further.

Limitations of Rupee Cost Averaging

Higher transaction cost

Buying the securities frequently in smaller quantities may result in higher transaction costs and charges. 

Averaging is not the solution always

Averaging is not the solution when the share price is continuously going down. Investors tend to average out the stocks at every dip. But one point to consider here is that investors should average out only those stocks that are fundamentally strong. Averaging out fundamentally bad stocks will only result in losses eventually.  

Let’s take the example of Yesbank here. Since 2018, the stock has been trading at the level of 400 roughly.  But due to degrading fundamentals, it's now trading at the level of 12. If as an investor you would have averaged out the stock at every level it would have become very difficult for you to remain in profit in this stock. Thus, investors should be very cautious when it comes to averaging stocks and only fundamentally strong stocks should be averaged out. 

Conclusion

You see, there are various ways by which you can safeguard your investment and optimise your returns. It's just that you have to know about these concepts and that you can do only by continuous learning. 

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Investing smartly can grow your net worth by 40%, and Quest will make you aware of investing and the secret to increasing wealth. As against popular opinion, you do not always need to earn more money to be rich. 

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Also, Is there any topic you want a blog on or do you have any queries related to this blog? 

Then write us at support@finology.in 

We love it when you communicate with us. Do write in the comment section if you liked the blog.. :) Until then, Happy Investing.

About the Author: Ayushi Upadhyay | 234 Post(s)

A Keen Learner.
Passionate for Creative Writing & Finance!

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