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People invest in the stock markets to get returns that are much better than the debt instruments. In order to achieve their goals, they try to time the markets. There is an involvement of lots of emotion and sentiments and people can get it wrong in the process; buying when the market is rising and selling when the market is falling. Timing the market is like speculation and even the most experienced investors and professionals can go wrong. The ones likely to suffer the most are the new investors who don’t have any experience in the stock markets.
Rupee cost averaging helps individuals to come out of the game of speculation and invest a fixed amount of money at regular intervals. It is not in any way dependent on the rise and falls of the markets and eliminates the risk of timing the markets. An investor is relieved of decision-making and uncertainty when they are not sure of the movements of the market.
Rupee cost averaging is used to invest in mutual funds and helps investors to be disciplined in their approach. Mutual funds can beat inflation over the longer term and generate wealth for the investors. When an individual invests in mutual funds in a disciplined manner there is a benefit of compounding.
When persons apply rupee cost averaging they get more units in a falling market and a lesser number of units when the markets are rising. This brings down the average cost of investment per unit in the long run. This way anyone can ride the volatility of the market. The way to invest in mutual funds and use rupee cost averaging is through a systematic investment plan (SIP). In the systematic investment plan, a fixed amount of money is invested at regularly defined intervals in a mutual fund scheme. The amount could be very low as much as only Rs. 500 and can be invested on a weekly, monthly, or quarterly basis. The investments are in a time-bound manner and the investor doesn’t have to worry about the condition of the market.
Let us take an example. Ramesh decides to invest Rs. 5000 every month in the units of XYZ mutual fund in the systematic investment plan (SIP).
Following observations can be made from the above table-
1) In the first six months of the year 2021 the unit price of the mutual fund kept on increasing so the number of units purchased kept going down.
2) From July onwards the price of the units dropped due to the market condition and the number of units purchased increased.
3) The first investment cost Rs. 50 and there was an increase and decrease in unit price, but the disciplined approach even during the bad times brought the average cost of the purchase to Rs. 49/Unit thereby earning a profit.
Advantages of rupee cost averaging-
1) There are many people who are busy in their jobs or business and can’t track the markets on a regular basis. Rupee cost averaging is useful for them as they can initiate a SIP on a pre-defined date.
2) There are new investors who don’t know about the movements of the markets and in their effort to earn money quickly are possessed by greed and often tend to lose money. With the SIP they can invest in a disciplined manner.
3) When SIP has been initiated people fall into the habit of investing at regular intervals.
4) When the mutual fund units are held for a long time there is a benefit of compounding.
5) When SIP is carried on during the bear markets, due to the falling price the average price/cost of the mutual fund units becomes lower.
6) SIP can be carried out with affordable monthly installments.
In SIP the investor gets the advantage of averaging in an automated manner. The amount gets auto-debited from the account. Rupee cost averaging is good for the long term and can reduce the risks of investing in volatile markets.