Rupee Cost Averaging is an investment technique that helps to reduce the impact of volatility on purchases of equity or equity like products. Rupee Cost averaging is known as dollar cost averaging in the US, pound cost averaging in the UK and unit cost averaging in general.
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).
Rupee Cost Averaging helps in 2 ways.
- In a falling market, rupee cost averaging helps in minimizing downside risk.
- In a rising market, rupee cost averaging reduces upside potential but provides the convenience of investing in small amounts, when one does not have the full amount readily.
The technique is called Rupee Cost Averaging as it can potentially reduce the average cost of shares bought in a falling market.
Illustration of Rupee Cost Averaging
Mr Rajvardhan wants to invest Rs 5,000 per month in his favorite mutual fund. He starts investing and the market tanks. From an initial price of Rs 71 in Month 1, the price goes down all the way to Rs 60 in Month 12.
This is where the benefits of rupee cost averaging come to play. The lower the prices go, the more the number of units Mr Rajvardhan gets.
Total Investment – Rs 60,000.
Total Units – 935.43.
Average buying price – Rs 64.14.
Current NAV – Rs 60.00.
Value of Investment – RS 56,126 (Rs 60 X 935.43 ).
His average buying price is Rs 64.14, down from his initial buying price of Rs 71. His effective loss per unit is therefore Rs 4.14 (Rs 64.14 – Rs 60).
If Mr Rajvardhan had not done rupee cost averaging, his loss would have been Rs 11 (Rs 71 – Rs 60).
Rupee Cost Averaging helps to minimize the impact of short term market fluctuations, especially in a markets going down.
- As the periodic amount is fixed, one is able to buy more units when prices are low, and hence reduce average buying price.
- 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. When the markets go up, an investor does not know how high it will go or for how long. So the best approach is to invest the same fixed amount every month.
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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 Rupee Cost Averaging useful. If you have something to add please leave a comment in the post. Please feel free to contact me.