Rupee cost averaging can help reduce the cost of investing while maximising your returns. Read on to find out how this can help lower the cost of investing over the long-term.
Rupee cost averaging is an age-old concept. It is a method of investing that helps you maximise returns in the long term. This method involves making a fixed amount of investment on a regular basis, regardless of fluctuations in the asset price. Typically this method of investing is used for buying shares and Mutual Funds, as prices of these investments tend to be volatile.
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When you follow rupee cost averaging in a volatile market, you can purchase more (shares or Mutual Fund units) when the prices are low and make lower investments when the prices are high. How? Let’s assume you have chosen an Equity Mutual Fund. The equity markets seem volatile. So, you take to rupee cost averaging to maximise your returns and make investments as below.
| Month | Investment | Unit price | Units purchased |
| 1 | 2000 | 20 | 100.0 |
| 2 | 2000 | 18 | 111.1 |
| 3 | 2000 | 17 | 117.6 |
| 4 | 2000 | 16 | 125.0 |
| 5 | 2000 | 17 | 117.6 |
| 6 | 2000 | 19 | 105.3 |
| Total units | 676.7 | ||
| Lump sum | 12000 | 20 | 600 |
In the above example, the rupee cost averaging method of investing ensures that you get more units as opposed to making a lump-sum investment. If you had made a lump-sum investment, you would have got only 600 units of the Mutual Fund. But with rupee cost averaging, you get 676 units, a gain of close to Rs. 1,500.
Also, note that when prices are high, you buy fewer units. For example, when the price was Rs. 16 you bought 125 units but when the price rose to Rs. 19, you purchased only 105 units. So, essentially you are investing more when prices fall, which will maximise your returns.
Additional Reading: Mutual Funds: The Difference Between Growth & Dividend Funds
Now, what happens when the market is falling constantly?
You gain even more. Here’s another example.
You chose to invest in a Mutual Fund that is currently trading at a Net Asset Value of Rs. 30. Experts advise that you should use rupee cost averaging because the Indian equity markets are on a bear run, that is, they are falling. So, you invest as below:
| Month | Investment | Unit price | Units purchased |
| 1 | 2000 | 30 | 66.7 |
| 2 | 2000 | 27 | 74.1 |
| 3 | 2000 | 25 | 80.0 |
| 4 | 2000 | 24 | 83.3 |
| 5 | 2000 | 22 | 90.9 |
| 6 | 2000 | 19 | 105.3 |
| Total units | 500.2 | ||
| Lump sum | 12000 | 30 | 400 |
Here, when you use the rupee cost averaging method, you are able to purchase 500 units. But when you use the lump sum method you get only 400 units. The gain from using the rupee cost averaging method is 121 units or Rs. 2,300. Again, you buy more units when the prices fall, leading to higher returns.
Not Always
However, note that when the markets rise, rupee cost averaging is not a great method. Here’s another scenario. Let’s assume you invest in a Mutual Fund when the markets are going up, as below:
| Month | Investment | Unit price | Units purchased |
| 1 | 2000 | 20 | 100.0 |
| 2 | 2000 | 22 | 90.9 |
| 3 | 2000 | 24 | 83.3 |
| 4 | 2000 | 26 | 76.9 |
| 5 | 2000 | 28 | 71.4 |
| 6 | 2000 | 31 | 64.5 |
| Total units | 487.1 | ||
| Lump sum | 12000 | 20 | 600 |
Here, by using the rupee cost averaging method, you actually lose because you are purchasing lower units. Through the rupee cost averaging method, you get 487 units only whereas while using the lump sum method you are able to purchase 600 units. The loss here is 113 units or Rs. 3,500. This is precisely the reason why you should know when to use this method.
When do I use it?
Rupee cost averaging gives you the best results when you are investing for the long term. This will be 3 or more years. This is because equity markets tend to be volatile in the long run.
You can follow another method for even higher returns. Whenever the market falls by more than 10%, invest twice the amount you would invest normally. This will most likely maximise your returns. Don’t know much about Mutual Funds? Get help from experts.
Additional Reading: Best Investments for Long Term Growth in India