What is Rupee Cost Averaging?
Your parents must have used traditional investment avenues such as fixed deposits (FDs), gold, and government securities to build their wealth. These were sufficient to enable them to achieve their financial goals because their wants were limited and more importantly, the rate of inflation was not high. However, due to declining interest rates and higher inflation FDs, bonds, and recurring deposits (RDs) are not able to deliver good returns. One way to overcome these limitations is to invest in direct equities. However, such investments are very risky especially if you do not have the financial and technical knowledge required to identify well-performing stocks.
Mutual funds mitigate the risks of direct equity investing while delivering inflation-beating returns when you stay invested for the long-term. Mutual fund investment is very simple and flexible. You do not require a large lump sum to invest in such funds. You may invest only INR 500 per month through a Systematic Investment Plan (SIP). SIPs allow you to invest a pre-determined amount at regular intervals in your chosen mutual funds. In addition to being light on your wallet, a major benefit of SIP is rupee cost averaging.
What is rupee cost averaging?
Rupee cost averaging is the averaging out of the cost of your mutual fund investments. The stock market is volatile because some days it may close at a high while on other days it may be at a low. If you want to profit from direct equities, you must be able to time the market. This means you buy the shares when prices are lower and sell when prices rise. However, timing the market is almost impossible even for seasoned investors.
Therefore, equity SIPs enables you to maximize the mutual fund returns. A certain amount is invested in your chosen fund when you invest with an SIP. Therefore, when the Net Asset Value (NAV) of the fund is lower, you accumulate more units. Similarly, when the NAV is higher, you accumulate lesser units. An SIP automatically allows you to benefit from the market volatility. With the inbuilt mechanism, you are able to reduce the average cost of your total investments, which is the primary concept of rupee cost averaging.
How does rupee cost averaging work?
To help you understand better, here is an example of how rupee cost averaging works. Assume you invest INR 25000 per month is an equity mutual fund. During one month, the markets are at a low, which reduces the fund’s NAV to INR 250 per unit. This means your SIP installment acquires 100 units of the chosen fund.
In the next month, there is a recovery in the stock market, which results in the NAV to rise to INR 500 per unit. Your SIP amount allows you to purchase only 50 units of your chosen fund.
The average cost of your investment in this example works out to approximately INR 333 per unit. Therefore, when you exit your investments, you are able to earn higher mutual fund returns because your average cost is lower when compared to if you had purchased all the units at the same NAV. Thus, rupee cost averaging allows you to increase your gains.
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