Rupee Cost Averaging

by Gopal Gidwani on December 27, 2009 · 0 comments

in Others,Uncategorized

Rupee Cost Averaging – Get More Value for Your Buck 

Introduction
Sameer is a common investor. He wants to invest in the stock market, but is worried that the market will fall after he invests as the market has run up too much too fast. But at the same time he is worried that the market may continue to rise without a meaningful deep correction as it has being doing so since the last 2-3 months and he might miss the rally and the potential gains that he would make with it. Sameer is in a dilemma whether he should jump into the market immediately at the current level or continue waiting for the correction which refuses to come. In short here Sameer is trying to time the market which lot of common investors try to do. Many a times common investors get it wrong when they try to time their market entry and have burnt their fingers due to the market fall post their investment. Or many a times many investors have been left on the sidelines watching the markets go up, waiting for the correction endlessly which never comes through when required.

Concept of Rupee Cost Averaging
The simple solution to the problems of people like Sameer is Rupee Cost Averaging. It is very difficult for a common man to predict the day to day movement of the stock markets. Hence it is best to start investing on a staggered basis by making regular monthly investments. This helps the investor to spread out his investments evenly over a period of time. This process of making regular monthly investments over a period of time at various market levels is known as Rupee Cost Averaging. It is not always possible for an investor to buy at the lowest point and sell at the highest point. Rupee cost averaging helps the investor to reduce this risk of timing the market to a great extent.

For example Sameer can decide to make a regular monthly investment of Rs 100 in a mutual fund through a SIP.
Month 1: If in the first month the NAV is Rs 10 Sameer will be able to buy 10 units. So in the first month the average acquisition price is Rs 10 per unit.
Month 2: If in the second month the NAV rises to Rs 12 Sameer will be able to buy 8.33 units as compared to 10 units that he was able to buy in the previous month. At the end of the 2nd month the average acquisition price of the 20 units bought so far is Rs 10.91 per unit.
Month 3: If in the 3rd month the NAV falls to Rs 7 Sameer will be able to buy 14.2 units as compared to 8.33 units in the previous month. In the 3 rd month Sameer’s average acquisition price of the 30 units bought so far is Rs 9.22 per unit whereas the actual average NAV for the 3 months is 10+12+7/3 = Rs 9.66. Had Sameer invested the entire Rs 300 in the 1st month itself, he would have been able to buy 30 units of the mutual fund. But by investing Rs 100 every month in a staggered manner, Sameer has been able to buy 32.53 units. So due to rupee cost averaging he has 2.53 extra units in his account. But one needs to remember that if the NAV keeps going up continuously over the period of 3 months then Sameer would have been able to buy less than 30 units. So if the market keeps rising continuously then lumpsum investment gives more returns than staggered investments. But markets being volatile by nature no one can predict the direction of markets and hence its better to play safe by investment through systematic investment plans (SIP).
So in the 3 months the NAV of the mutual fund has fluctuated between a low of Rs 7 and a high of Rs 12. In the 3 months Sameer has been able to buy at an average price of Rs 9.22 per unit despite the fluctuation in the NAV of the mutual fund.
Rupee Cost Averaging helps the investor to buy more units of the mutual fund when the NAV is low and buy less units of the mutual fund when the NAV is high. But eventually the price gets averaged out over the long term. Thus rupee cost averaging helps in lowering the average acquisition price of the units but for this to happen the investor has to be disciplined enough to invest on a regular basis.

Benefits of Rupee Cost Averaging
From the above discussion, in short the benefits of rupee cost averaging can be summarized as follows:

  • Inculcates the habit of regular disciplined investing
  • Helps to ride out market volatility
  • Protects the investor from incurring huge losses when the market falls drastically by averaging the purchase price at lower levels.
  • Rupee cost averaging works at the time of buying securities as well as at the time of selling the securities.
  • It frees the investor from the tension of trying to time the market or predicting the direction of the market and hence the problem of buying low and selling high.
  • It helps the investor to buy more units when the market is down and buy fewer units when the market is high.

Scenario Based Example
Let us take the example of an investor. Sunny decides to invest Rs 100 every month in a SIP for 12 months. When Sunny starts the investment the NAV is Rs 10 and he gets 10 units. During the course of the year the NAV keeps moving up and down. So Sunny also keeps get units worth Rs 100 as per the movement in the NAV price.

MonthMonthly Amount InvestedNAV (Price Per Unit)Units Bought

1

100

10

10.00

2

100

10.5

9.52

3

100

12

8.33

4

100

11

9.09

5

100

9.8

10.20

6

100

9

11.11

7

100

8.7

11.49

8

100

9.5

10.53

9

100

10.2

9.80

10

100

11

9.09

11

100

12.3

8.13

12

100

13.2

7.58

Total

1200

 

114.88

Total Amount Invested

1200

  
Actual Average NAV

10.60

  
Average NAV for Sunny

10.44

  

We can see from the table, Sunny invests Rs 1200 in the entire year and he gets 114.88 units for it. Sunny’s average cost per unit is Rs 10.44 whereas the actual average NAV is Rs 10.60.

Please do let us know your comments on the article at gopal_gidwani@yahoo.com


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