In this post I will talk about the benefits of rupee cost averaging.
Rupee Cost Averaging also known as dollar cost averaging is an investment technique that helps to reduce the impact of volatility on purchases of equity or equity like products. In a Rupee cost averaging strategy, an investor divides his total planned investment amount (say Rs 60,000) into equal amounts (for example Rs 5,000), and invests the amount periodically over a certain period (12 months). For a detailed introduction to the concept of rupee cost averaging, please read this post.
People who invest in shares, generally tend to invest more when markets go up and and invest less when markets go down. When markets crash, many in fact completely stop investing.
This is clearly wrong.
One should buy low and sell high.
But since we cannot predict the future, the best approach we can take is to invest a fixed amount regularly every month for a long period of time (say 3 to 5 years), so that we can average out the buying cost, which is nothing but rupee cost averaging.
Benefits of rupee cost averaging
- As the periodic amount is fixed, one is able to buy more units when prices are low.
- When one invests regularly, he does need to known when to enter and at what entry price, as long as he is convinced about indicative long term returns.
- Rupee cost averaging helps to reduce the short term impact of market fluctuations.
- Rupee cost averaging also helps psychologically, as it reduces stress associated with wild market fluctuations.
Psychological Impact of not doing rupee cost averaging
Mr Joshi decides to invest Rs 600,000 (RS 6 lakhs) in his favorite mutual fund.
Let us try to analyze Mr Joshi’s financial performance as the price moves from Rs 71 down to as low as Rs 62, before ending the year at Rs 75, for a 6% return.
If Mr Joshi is a normal investor, he will probably drop out after 2-3 months of losses. And if he does manage to stay invested for a year he will suffer anything between extreme anxiety and tension to super optimism.
By month 5, when his investment is down by 17% or Rs 100,000, in most likelihood he would be suffering from very high blood pressure, anxiety and tension.
All this for a 6% return.
Psychological Benefits of Rupee cost averaging
All this could have been avoided with rupee cost averaging as illustrated below.
With rupee cost averaging in action, Mr Joshi is able to buy more units at lesser cost and average down his cost. This psychological aspect is one of the most important benefits of rupee cost averaging.
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A Few Last Words
Before making any investment decision, please contact your financial adviser. I have provided this article for educational purpose only.
I hope you found this article on Benefits of Rupee Cost Averaging useful. If you have something to add please leave a comment in the post. Please feel free to contact me.