In plain English, Rupee Cost Averaging means investing regularly, regardless of what the market is doing. It's a way of making the value of your investment grow at the same time as removing the difficulty of "timing the market". In the long run, investing on a regular basis also helps to reduce your overall risk.
It's hard to time markets
Make no mistake, it's hard to time when to enter and exit markets. Financial markets are made up of a host of different investors. There are large institutions, such as fund managers, as well as companies, brokers and individual investors. Over the long-term, markets can do well but in the short term, prices fluctuate on the basis of fundamental news, market sentiment, expectations, rumour and competitor activity.
Sometimes the 'herd' mentality can set in. When the news about a particular stock is good, investors buy in. Even though the price keeps rising, buyers keep buying, as nobody is sure when the price has peaked. Similarly, when prices are falling, nervous investors sell in an attempt to cut their losses.
There are statistical measures and yardsticks, such as price-earning ratios, which help determine the true value of a stock or bond, but as the boom and bust in Internet stocks has proven, rational measures are often ignored and sentiment can take over. Deciding when to invest in this environment can be a stressful task. If the market is doing well you may fear that you're buying when prices are too high. By contrast, when the market is falling, there is a reluctance to invest due to fears that it may fall further. So what should an investor do to avoid having to make these timing decisions?
Why investing regularly works?
Investing on a regular basis removes the stress of "timing the market" because you are employing the concept of "Rupee Cost Averaging". If you are an investor in mutual funds it means that you buy more units when the purchase price is low and fewer units when the purchase price is high. The trick to all this is to remember that it's not the price you pay for each unit that matters. It's the average price per unit over time that determines your overall return.
Rupee cost averaging in action
Lets look at an example to make all this a bit clearer. Ajay has been investing Rs 5,000 per month in a particular equity fund scheme since October 1999. The table below shows the purchase price Ajay paid for the units each month as well as the number of units Ajay purchased.
| Regular Date | Investment | Purchase Price per Unit | No. of Units received |
|---|---|---|---|
| Oct 1999 | Rs. 5,000 | Rs. 10 | 500 |
| Nov 1999 | Rs. 5,000 | Rs. 9 | 556 |
| Dec 1999 | Rs. 5,000 | Rs. 9 | 556 |
| Jan 2000 | Rs. 5,000 | Rs. 8 | 625 |
| Feb 2000 | Rs. 5,000 | Rs. 7 | 714 |
| Mar 2000 | Rs. 5,000 | Rs. 7 | 714 |
| Apr 2000 | Rs. 5,000 | Rs. 6 | 833 |
| May 2000 | Rs. 5,000 | Rs. 6 | 833 |
| June 2000 | Rs. 5,000 | Rs. 6 | 833 |
| July 2000 | Rs. 5,000 | Rs. 7 | 714 |
| Sept. 2000 | Rs. 5,000 | Rs. 9 | 556 |
| Oct. 2000 | Rs. 5,000 | Rs. 10 | 500 |
| Total | Rs. 65,000 | 8,648 |
A brief glance at the table reveals the benefits of Rupee Cost Averaging. When the purchase price was high (eg. Rs 10 in Oct 1999), Ajay bought fewer units (500) and when the purchase price was low (eg. Rs 6 in Apr 2000), he bought significantly more (833).
The benefits of this strategy are twofold:
The average price Ajay paid for the units was Rs 7.52* (the total cost of the units - ie. Rs 65,000 divided by the total number of units purchased - ie. 8,648). This is less than the average market price over the period (Rs 7.77*) even though Ajay was not even trying to "time the market". In Oct. 2000, the value of Ajay's investment is approximately 33% higher than what it originally cost him (Original cost : Rs 65,000 Current value : Rs 10 x 8,648 units = Rs 86,480 ), even though the purchase price in Oct. 2000 was the same as it was in Oct. 1999 (ie. Rs 10). By investing regularly, Ajay bought units as the price was falling and was able to benefit from price appreciation as the market recovered. So Ajay has avoided the stress of timing the market but has still done very well on his investment. The key - Rupee Cost Averaging which, in simple terms, just means investing
regularly. *Approximate value rounded upto two decimal places.
Courtesy: dspblackrock.com
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