Rupee Cost Averaging: Meaning, Function, Benefits, and More

Investing in mutual funds can help surpass inflation while providing substantial gains over a long period. Systematic Investment Plans (SIPs) are one of the most common procedures for investing in mutual funds. The rupee cost averaging is one of them, which averages out the price by which an investor buys units of the mutual fund. 

Read this blog to understand the overall concept of rupee cost averaging, its advantages, and how it differs from lump-sum investing.

Rupee Cost Averaging Meaning

Many investors have tried to time their investments to increase their profits and minimise losses. However, they lost their capital because of the unpredictable nature of the market.

Rupee cost averaging (RCA) is a different approach from that, where a particular amount is invested in regular intervals, irrespective of the asset price. The rupee cost averaging entails purchasing more units when prices go down and fewer units when prices go up. Reducing the average cost per unit is the primary objective of this concept. This also mitigates the market risks and promotes disciplined investing among investors.

How Does Rupee Cost Averaging Function?

After knowing what is rupee cost averaging in SIP, it is essential to understand the function of rupee cost averaging. You put a fixed amount in your mutual funds schemes each month regardless of the Net Asset Value (NAV) of the funds. You will get more units when the NAV is low and fewer units when the NAV increases. Gradually, this can average the cost of investment and generate maximum returns in the bullish market. This tactic takes advantage of market volatility and makes you beneficial.

This example can help you to understand how rupee cost averaging works. Let’s say you want to start an SIP of ₹8,000 monthly in a mutual fund irrespective of the fund’s NAV. The NAV in the first month is ₹40, and you can buy 200 units. In the second month, the NAV surges to ₹80. Now, your investment of ₹8,000 lets you buy 100 units. In the third month, the market falls and the NAV drops to ₹20. Then you can buy 400 units for ₹8,000. 

After three months, you have invested a total of ₹24,000 and purchased 700 units from the mutual fund. Now you need to divide the total invested amount by the total number of units you have acquired to get the average cost per unit.

Amount invested: ₹24,000

Total units acquired: 700 units

Average Cost per Unit: ₹24,000 / 700 = ₹34.28

Now let us consider this situation without rupee cost averaging. For instance, you have to pay ₹56,000 to acquire 700 units in the second month, when the NAV is ₹80. This will be much more expensive than your total investment of ₹24,000.

However, if you have purchased all the units in the third month with an NAV of ₹25, you have to pay only ₹14,000. It is very less but relies on the improbable possibility of buying at the lowest price by precisely timing the market.

Qualities of Rupee Cost Averaging

A rupee cost averaging generates more units for investors during the bearish market. These are the characteristics of RCA:

• Daily Investments: RCA keeps inventors committed to investing a fixed amount in each month or quarter regardless of the market conditions. This helps an investor to be consistent and disciplined while investing.
• Reduces the Impact of Volatility: The RCA allows an investor to acquire more units at a lower price and fewer units at a higher price. This keeps the investments safe from the effects of a volatile market.
• Reduced Average Cost: This concept can reduce the average cost per unit of a fund by diversifying the invested funds in different market conditions.

Advantages of Rupee Cost Averaging

RCA helps in disciplined investment, by making investors contribute a predetermined amount in each month or quarter. Below are some of the benefits of rupee cost averaging that you can avail while investing in SIPs:

• Lowering the Average Purchase Price: You can easily reduce your average purchasing price over time using rupee cost averaging in SIP. It divides your investment over some periods, in contrast to other investments, where the purchase price is set at the moment of investing. You can buy more units for the same amount of money when the market price is lower. 
• Accessible Investment: With an SIP, you can start investing by any amount. This low barrier of entry is one of the primary advantages of the rupee cost averaging. You may start investing with tiny and manageable sums each month as low as ₹500. This can help you maintain a habit of regular savings. It will be easier to start saving funds without a large amount of capital.
• Address the Risks of Market Volatility: If you are an investor with a lower risk tolerance, you might face concerns regarding market volatility. Significant losses can result from extreme volatility if you have chosen a high-risk option. By spreading assets across time, RCA safeguards you from the negative impact of market fluctuations.
• Less Stress: RCA also helps you make investments in the markets without stress and anxiety to maintain a perfect timing for your investments. This makes your investment journey convenient and predictable.
• Facilitate Hedging: Rupee cost averaging also allows you to facilitate hedging. You can easily secure your portfolio against market downturns while balancing your assets between debt and equity securities. While debt investments can provide security and steady returns during bearish markets, you can have the potential to yield large gains during bull markets from equity investments.
• Enhance Diversification: You will be able to maintain a diversified portfolio while making regular investments in different mutual fund schemes. This lowers the risk and enhances the potential for steady returns.

Key Differences of Rupee Cost Averaging vs Lump Sum Investment

As you have come across the benefits and characteristics of rupee cost averaging, let us now understand how it is different from lump-sum investment:

Who Needs to Use Rupee Cost Averaging?

A rupee cost averaging strategy is an ideal choice for an investor who prioritises long-term financial objectives like achieving retirement, and education. Additionally, RCA can help to make steady and regular investments towards these objectives.

The RCA is also helpful for those who want to secure their investments from market volatility. The rupee cost averaging evens out the effects of market volatility by purchasing more units when prices are low and fewer when they are high. Therefore, for investors who want greater stability and expand their portfolio, the rupee cost averaging in SIP can reduce their stress for market volatility.

Typical Errors to Avoid in Rupee Cost Averaging

You need to avoid the below typical errors in rupee cost averaging that can lead to complacency and losses: 

1. You might be too passive as the RCA reduces your stress for market timing. This can help you avoid mandatory portfolio adjustments that can produce returns.
2. You must avoid using rupee cost averaging if your goals are short-term oriented. Otherwise, this approach can limit your potential to gain significant returns.
3. You need to become aware of the investment platform as they can charge fees that can potentially reduce your returns. You must consider calculating these fees and ensure you get higher returns using the RCA.

Final Thought

A rupee cost averaging is an essential concept of mutual funds SIP that offers discipline among investors and lowers the average costs in mutual funds. Risk-averse investors with long-term potential are beneficial using this approach. However, you must be aware of mistakes like avoiding portfolio adjustments and short-term goals.

You can also enjoy the benefit of rupee cost averaging by starting SIPs from Torus Digital. Download the Torus Digital application and open a Demat account for free. Torus Digital offers you the privilege to start SIPs from just ₹100.

Frequently Asked Questions

• What is Rupee Cost Averaging?

Rupee cost averaging is a method of investing that reduces the effect of market volatility. This process divides the entire investment amount over periodic purchases of a particular asset.

• What distinguishes Rupee Cost Averaging from a SIP?

Although it is a part of SIP investment, rupee cost averaging is different from it. A SIP is a process of investing in mutual funds, whereas an RCA is a benefit provided by it.

• Does RCA ensure guaranteed profits?

No investment approach ensures guaranteed profits. Rupee cost averaging in mutual funds helps to reduce the effects of a volatile market. It also reduces the average cost per unit over time.

• Is Rupee Cost Averaging applicable to stock investing?

No, rupee cost averaging is not applicable for stock investing. The RCA is an essential component of SIP, which is a procedure to invest in mutual funds.