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 rupee cost averaging?
2. How does rupee cost averaging work?
3. Characteristics of Rupee Cost Averaging
4. Advantages of rupee cost averaging strategy
5. How does rupee cost averaging help?
6. Is rupee cost averaging beneficial for all investors?
7. Is SIP helpful in bull or bear markets?

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 work?

Let’s assume you invest Rs 1,000 monthly in a mutual fund:

In Month 1, with an NAV of Rs 50, you get 20 units (1,000/50).

In Month 2, as the NAV drops to Rs 40, you acquire 25 units (1,000/40).

In Month 3, when the NAV rises to Rs 60, you receive 16.67 units (1,000/60).

Your total investment of Rs 3,000 results in 61.67 units at an average cost of Rs 48.65 per unit (Rs 3,000/61.67), which is less than the initial NAV of Rs 50.

Characteristics of Rupee Cost Averaging

Rupee cost averaging through Systematic Investment Plans offers a structured approach to investing, characterised by:

Regular fixed investments: SIPs involve investing a predetermined amount at consistent intervals, like monthly or quarterly.

Varying fund prices: The Net Asset Value (NAV), or price per mutual fund unit, fluctuates daily based on market conditions.

Buying more units in a falling market: When the NAV is lower, your fixed investment buys more units. This allows you to potentially capitalise on lower prices and make gains if the market recovers.

Buying fewer units in a lower market: Conversely, when the NAV is higher, your investment buys fewer units. As a result, you avoid overweighting your portfolio during market peaks.

Cost averaging: Over time, this approach lowers your average cost per unit, enhancing net potential gains.

Advantages of rupee cost averaging strategy

• Lower average purchase price: When you invest in a lumpsum, your per-unit purchase price is determined at the time of investment and remains constant. However, with the rupee cost averaging strategy, you invest in smaller amounts at regular intervals. This approach allows you to buy more units when the NAV is low, typically resulting in a lower average cost per unit over time.
• Cushion against volatility: While seasoned traders may know how to potentially benefit from market volatility, new investors will find it challenging to time the market. Rupee cost averaging helps mitigate the impact of market fluctuations on your investment. For instance, during market dips, you can buy more units at lower prices, potentially increasing returns when the market recovers.
• Promotes disciplined investing: SIPs encourage consistency in investing, making it a habit that grows wealth steadily.
• Accessibility: SIPs allow investors to begin with small amounts, making them an accessible option for a wide range of individuals.
• Potential for long-term gains: Consistent contributions through SIPs benefit from the power of compounding, which can lead to higher returns over time.
• Risk tolerance: Those with a low risk tolerance may find SIPs, with their steady and consistent approach, more comfortable.

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.

Per-annum invested	Year	NAV	Units purchased
Rs 1,000	2018	Rs 10	100
Rs 1,000	2019	Rs 8	125
Rs 1,000	2020	Rs 6	166.67
Rs 1,000	2021	Rs 10	100
Rs 1,000	2022	Rs 12	83.33

* 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.

Is rupee cost averaging beneficial for all investors?

The reduction in per-unit prices can be beneficial to any investor, but the other mechanics of rupee cost averaging – i.e, investing in fixed instalments over time – may not be suitable for investors who have the following objectives:

Very short term goals: SIPs and rupee cost averaging work optimally in the long term. In the short term, if prices are rising, rupee cost averaging could even increase the per-unit price. Moreover, if your investment horizon is less than a year, a lumpsum investment in a low or moderate risk debt mutual fund may be more optimal because your entire capital will get market exposure at once.

Market experience: Experienced investors with a good understanding of market cycles may seek to leverage market movements by trying to time the market and adapt the investment amount to market movements. However, market timing is a very risky approach.

Is SIP helpful in bull or bear markets?

SIPs offer advantages in both bull and bear markets, with the benefits varying depending on market conditions.

• Bull market: In a rising market, the value of your investments generally increases, and SIPs help you stay invested consistently to potentially benefit from this upward momentum with a long-term growth approach.
• Bear market: In a declining market, SIPs help you buy units at lower prices, which can lead to potentially higher gains when the market recovers. Since SIPs involve regular investment, they enable you to benefit from market corrections over time, lowering your average cost per unit.

In summary, SIPs are most effective for long-term investors because they allow you to invest regularly regardless of market conditions, helping smooth out short-term market volatility. However, their effectiveness is more apparent when the investor stays disciplined and is patient, even during downturns.

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. Using an SIP calculator online can help you visualise the potential growth of your investments over time. This can help encourage you to stay invested during volatility despite the ups and downs.

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 can help investors assess this. 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.

How can I invest through rupee cost averaging?

Rupee cost averaging is not an investment mode, it is a by-product of investing a fixed amount at regular intervals. In mutual funds, the most convenient way to do that is through SIPs.

How do you calculate cost averaging?

To calculate the average cost per unit in mutual fund SIPs, sum the total investment and the total number of units purchased, then divide the investment amount by the units acquired. For example, if you invest Rs. 3,000 and acquire 61.67 units, your average cost per unit will be Rs. 48.65.

What are the drawbacks of rupee cost averaging?

Rupee cost averaging through SIPs helps reduce the impact of market volatility but does not guarantee profits, especially during prolonged downturns. It is most effective for long-term goals but may not be ideal for short-term investments or rising markets. The strategy offers a systematic approach to investing, though it may limit flexibility and diminish returns as the portfolio grows.

What is rupee averaging?

Rupee cost averaging happens when investors regularly invest a fixed amount in an asset, such as a mutual fund, regardless of its price. This approach buys more units when prices are low and fewer units when prices are high, averaging out the cost over time and potentially lowering the overall cost per unit. It offers advantages like reduced volatility impact and disciplined investing.

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.