Decoding the jargon: Rupee Cost Averaging (“RCA”)
To understand Rupee Cost Averaging, let us go back to the basics. Our aim in life is to earn profits through our investments. To achieve this, we look at optimizing our purchases when the prices are low. This is akin to buying groceries when there are discounts and then rationing it when inflation makes them more expensive. A similar logic applies to our investments also.
It is advisable to buy the stocks when the market is low and sell them when the market is soaring. But many investors tend to take the reverse path either due to lack of knowledge or panic. They tend to buy when the market is on its way up and then sell, when the market is not doing so well, - . Perhaps it will be ideal to be able to predict the market’s ups and downs, but unfortunately, it is difficult to time the markets . It may cause losses or very low profits, if at all. This is where Rupee Cost Averaging comes into play. It helps you to buy more when costs are low and buy less when the costs are high. This requires investments in small chunks over a period of time, which brings us to the concept of Systematic Investment Plan (SIP) in mutual funds.
How does SIP help in Rupee Cost Averaging?
When investing in mutual fund schemes, you may choose one of the two modes of investment- lump sum or SIP. While lumpsum implies that you invest all your money at one go; an SIP, on the other hand, is breaking down that amount into small chunks and investing systematically/regularly every month or quarter or any other allowed and pre-defines regular interval.
Rupee Cost Averaging is one of the primary benefits of investing via SIP. Especially when investing in an equity mutual fund and dealing with higher market volatility, RCA via SIP can ensure that the costs of your investments get averaged out over a longer period of time.
For those who are new to the concept of SIP and rupee cost averaging, allow us to explain with an illustration -
Here, we look at the difference between the investments (Rs 1,20,000) made in Scenario I- Lumpsum and Scenario II- SIP, in a volatile market condition. In Scenario I, an amount of Rs 120,000 is invested in one go in Jan’20 resulting in the buying of ~1191.89 units of the scheme, whereas, in Scenario II, the same amount is spread over a period of 12 months starting with Jan’20 with a monthly SIP of Rs 10,000, resulting in buying a total number of ~ 1200.15 units.
While in lumpsum investment, you bought all the units on day 1 at what was the NAV of the scheme on that day; with SIP, you were able to spread your purchase over a period of time. This ensured that you bought more units when the NAV was low and vice versa. Hence, your cost of purchase was averaged out resulting in a lower average NAV during a 12-month period.
Below are the major takeaways from this example-
- - For the lumpsum investment, we were unable to reap benefits of the time when the NAV of the fund was lower than the buying price of the fund.
- - For the SIP, however, having the investment amount fixed helped us in buying more units when the market was low and buying less when the market was high.
- - The averaged NAV in Scenario II is lower than the purchase NAV in Scenario I leading to a greater number of units bought with the same investment value.
The Rupee Cost Averaging benefit in SIP can help us in spreading out our investment in such a way that we may be able to maximize our gains. This also can help in comparatively reducing the market volatility-risks associated with your investments. Moreover, SIP is also a psychological discipline inculcated in our minds inspiring us to be regular with our investments rather than waiting for a lumpsum amount to be accumulated.
When does Rupee Cost Averaging help a mutual fund investor?
- - When the markets are volatile in nature
- - Ideally suitable for a long-term investment
- - When the investor cannot monitor the market movement on an ongoing basis
- - When the investor is looking for a fixed amount of disciplined investment
RCA helps you in averaging out your costs by spreading them over a period of time. It may not be easy to be able to predict the market or the fluctuation of NAV, and here is where RCA may come to your rescue by ensuring that you buy lesser units when the NAV is high and buy more when the NAV is low.