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Rupee Cost Averaging & How Does It Work

24 Nov 2023

Introduction:

Investing in market-related instruments such as stocks and mutual funds can be rewarding. But while the allure of high returns is enticing, the inherent volatility can make even the most seasoned investors uneasy. In light of this, several investors turn to investment strategies that can help them mitigate the risks associated with equity instruments and build wealth over the long term.

One such strategy is Rupee Cost Averaging (RCA). It is an investment technique that helps you balance out your cost of investments and gain maximum returns. In this article, you will explore rupee cost averaging, how it works, and how it can help you in your equity investment journey. Keep reading.

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What is a Systematic Investment Plan?

Before diving into the concept of rupee cost averaging, you must understand what a Systematic Investment Plan or SIP is. Investing fixed amounts in a specific stock or mutual fund at pre-determined time intervals is an investment method. The investment intervals can be weekly, monthly, quarterly, semi-annually, or annually. 

The SIP is an excellent option for investors with little or zero knowledge of the market. It allows you to make disciplined investments in a stock or mutual fund without worrying about timing the market. In the case of a mutual fund, you can start a SIP with Rs. 500, while for stocks, it depends on case to case.

What is Rupee Cost Averaging?

One of the advantages of investing through a SIP is that it allows you to leverage the benefits of rupee cost averaging. When you start a SIP in a stock or mutual fund, you sign up to invest a fixed amount on a fixed date every month, regardless of the market conditions. Depending on the asset's current market price per unit, you are allotted units in your portfolio.

During bullish markets, the asset's price is usually on the higher side, so you buy lower units. Similarly, during bearish markets, the asset's price is lower, resulting in the purchase of a higher number of units. You keep purchasing these units, and ultimately, your investment cost gets averaged out in the long term. This phenomenon in investing is known as rupee cost averaging.

How does rupee cost averaging work?

Let’s take an example to understand how rupee cost averaging works. Suppose you have started investing Rs. 10,000 monthly in a stock ABC through a SIP. Considering market volatility, your average cost of purchase per share after six months can be calculated as follows:

Month Market Price Per Share Investment Amount No. of Shares Purchased
First Rs. 100 Rs. 10,000 100
Second Rs. 95 Rs. 9,975 105
Third Rs. 90 Rs. 9,990 111
Fourth Rs. 102 Rs. 9,996 98
Fifth Rs. 105 Rs. 9,975 95
Sixth Rs. 110 Rs. 9,900 90

So, after six months, you would have invested Rs. 59,836 in the ABC stock to purchase 599 shares. Your average purchase cost would be Rs. (59,836 / 599), i.e., Rs. 99.89 per share, which is still less than the initial market price of Rs. 100 per share despite the market volatility.

Benefits of Rupee Cost Averaging

Below are a few benefits of the rupee cost averaging:

  • Eliminates the need to time the market

One of the advantages of rupee cost averaging is that it eliminates the need to time the market, a task that even the most seasoned investors may find challenging. Regular investments at fixed periods smooth out the impact of market volatility and average out your investment cost.

  • Encourage disciplined investing

The rupee cost averaging strategy instils discipline in investors by encouraging them to stick to a pre-determined investment plan. This helps them avoid emotional decision-making during market ups and downs.

  • Long-term wealth accumulation

The rupee cost averaging strategy allows you to accumulate long-term wealth by capitalising on market downturns and benefiting from compounding returns.

  • Reduced stress

Investors using the rupee cost averaging strategy often experience reduced stress levels, as they are not constantly trying to time the markets. This allows for a more patient approach to investing.

To conclude

Rupee cost averaging is a simple yet effective investment strategy for those looking to navigate through volatile markets and build long-term wealth. However, before investing, you must also consider your investment objectives, financial goals, and risk-taking capability. If you need a Demat account to start your investment journey, you can open it for free with Motilal Oswal.

 

Related Articles:  Understanding Stock Lending And Borrowing Mechanism | Why Share Market is Down and What You Should Do?

 

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