How rupee cost averaging works in SIP investments

When it comes to the financial market, a Systematic Investment Plan or SIP in mutual fund investment is considered relatively stable than the direct purchase of stocks and securities. This is especially true for those who have low risk tolerance or are new to investing.
Mutual funds can lessen the impact of market volatility because they are managed by financial experts and offer diversified portfolios. An additional advantage offered by an SIP investment, as opposed to a lumpsum, is the phenomenon of rupee cost averaging.
Rupee cost averaging can be considered as an inbuilt risk-reducing feature of an SIP investment. It helps withstand market fluctuations over the long term by reducing the number of units purchased when the market is up and increasing them when the market is down.
This article explains how rupee cost averaging works and how it can potentially minimize the impact of market volatility.

• Table of contents:

1. What is an SIP?
2. What is rupee cost averaging?
3. How does rupee cost averaging help?

What is an SIP?

An SIP investment requires you to set aside a pre-determined amount at fixed intervals (monthly, quarterly, and so on) into a mutual fund scheme of your choice. The amount is used to purchase units of the mutual fund scheme. The money invested accrues profits or losses depending on the market conditions.
SIPs help create a consistent and disciplined savings habit by allowing you to invest an amount of your choice at a consistent pace.

What is rupee cost averaging?

Rupee cost averaging in SIP is one of the key advantages of this investment route because it ensures that you acquire more units when the market is down and fewer when the market is up.
When the market is up, the prices of securities are high, and so is the price per unit of a mutual fund. When you make your SIP investment, you acquire fewer units for that fixed amount. When the market is down, the prices fall, the Net Asset Value or NAV of a unit decreases, and you buy more units for the same amount. As a result, the per-unit cost tends to average out in the long run.

How does rupee cost averaging help?

Rupee cost averaging in SIP helps you deal with market fluctuations while saving you the trouble of having to track the market. To reap potential benefits out of the stock market, investors are advised to buy low and sell high, that is, purchase stocks when prices are low and sell them at a higher price later. Doing this independently requires you to anticipate and track trends to time the market, which is a risky and difficult proposition.
Rupee cost averaging tends to pay off when the market is down, provided you stay invested. Over five years or so, the market usually stabilises. During this period, rupee cost averaging may likely lower the average price you spent per mutual fund unit, which may put you in a better position to benefit from the market’s resurgence. The SIP cost average phenomena may spread out your investments in such a way that the risks are reduced.
Let’s examine this further through an illustration.

* The information provided in this table is not based on real market figures and is for illustration purposes only.
In this scenario, the total amount invested at the end of five years is Rs 5,000. The number of units purchased is 575. This brings the per-unit average cost over 5 years to Rs. 8.69 (approximately).
In comparison, if you had invested Rs 5,000 lumpsum in 2018, the number of units purchased would stay constant at 500 – based on the Rs 10 NAV that year.
However, during a bull market – when the price of stock surges upward for a prolonged period – a lumpsum investment may earn relatively better returns because the NAV would keep going up and the rupee cost averaging phenomenon may even drive up the average per-unit cost of your investment.
Over longer durations though, markets rarely follow such a linear graph. Even when the overall sentiment is good, there will be phases of decline. Moreover, it is very difficult to predict a bull or bear market, so an SIP investment usually works out to be a relatively stable option, especially for those who are new to the financial market.

Conclusion

Rupee cost averaging through SIPs can reduce the risks associated with market-based investments over a long tenure. When you invest a fixed amount at regular intervals, you automatically buy more when prices are down and less when prices are up. This helps you leverage market volatility without having to track and time the market.

FAQs

What are some frequent errors that people make while buying a mutual fund scheme?

Investors frequently make the following mistakes when picking a mutual fund scheme, i.e., failing to have defined investment goals; failing to evaluate related risk before choosing a mutual fund scheme; failing to anticipate when they might need their investment.

Sometimes, investors may start an SIP without a clear vision of how much they need to invest to potentially reach their desired goal. An SIP calculator online can enhance the planning process. Based on the instalment amount, tenure and expected returns, the calculator estimates how much an investor can potentially earn. They can also input different investment amounts or tenures to determine what suits their goal. To complement this information, you may use a SIP calculator with step up feature. This tool allows you to see the potential returns when you gradually increase your SIP amount.

How exactly does rupee cost averaging operate?

To average out the cost of assets over time, rupee cost averaging is used. It seeks to reduce the risk of making significant investments at unfavourable peaks by investing a predetermined amount at regular intervals regardless of market movements.

What does the SIP rupee cost average mean?

A strategy for investing in mutual fund schemes is rupee cost averaging. When the price is low, you purchase more units of your chosen scheme, and when the price is high, you purchase fewer units. This aids in reducing the investment's overall cost over time.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.