Rupee-cost averaging is something that seasoned investors do when they invest in stocks. But as first-time investors lack the knowledge or expertise to continuously track the market, they are advised to invest via SIPs
SIPs have been a popular term among the investor community, and so is ‘rupee cost averaging’. Whenever one talks of investing through a systematic investment plan in an equity mutual fund, one makes sure to refer to rupee cost averaging.
Let’s understand what this exactly means.
The concept of rupee cost averaging lies in averaging out the cost at which you buy units of a mutual fund. The equity markets have always been volatile reflecting the ups and downs of the economy.
If you recall the law of demand, it says that a higher quantity of a commodity is purchased when it is least expensive. Conversely, the demand tends to reduce as the price of the commodity rises.
The fundamental principle of investing reinforces the same thing. It guides the investor to “buy-low and sell-high”. It means that you should buy more units of a mutual fund when the markets are down and fewer units when the markets are up.
However, most of the investors end up doing just the opposite. They start buying when the markets are rising and suddenly redeem upon a slump. Ultimately, their average cost of investing increases and returns fall.
But an SIP allows you to take the advantage of rupee-cost averaging in an automated manner.
Suppose you have a monthly SIP of ₹10,000 in an equity mutual fund. When the markets are low, the fund’s NAV falls to ₹200 and you get 50 units of the fund. Next month, the markets rise and so does the fund’s NAV to ₹500. This time, you get 20 units of the fund.
Hence, over the two months, your average per unit cost comes ₹285. When you sell the units, you will get higher value for your investments as compared to buying all the units at a higher price. This is rupee cost averaging, which increases your gains.
Rupee cost averaging works out best in choppy markets, but is useful even when the markets are in a bull run. It essentially helps you buy less when the markets are expensive and buy more when the markets are cheap.
An SIP is an easy way of doing this thanks to the benefit of rupee cost averaging.