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The benefits of rupee cost averaging
Pallavi rao in New Delhi | February 22, 2005 12:46 IST
There are many investors who like to park their money as a lumpsum into an asset class and forget about it. They don't want to worry about what's happening to it on a daily basis as long as the investment earns them some returns in the long haul.
That's not a bad idea at all and the safer the instrument, the lesser are your worries about returns.
But there is another way this lumpsum can be used -- by investing a fixed sum at regular intervals.
This method eliminates the need to time the market (making an entry or an exit) -- an area where most investors are prone to go wrong.
This method is commonly known as the rupee cost averaging.
Under this system, one need not worry about when and how much to invest. A fixed sum of money can be invested regularly and over time it averages out the costs.
For instance, if one were to buy units of a mutual fund -- by following rupee cost averaging, the fixed amount of money will fetch more units when the net asset value of the units are down, and vice versa.
What one must remember here is that what price you pay for a single unit does not matter but the average price at the end of purchase is what holds and the returns are based on this average cost.
This automatically falls in line with the age-old principle of buy low and sell high.
Rupee cost averaging, of course, does not inculcate the selling aspect. It only helps one average the cost of an asset purchase.
This helps in doing away with the volatility in the market since it smoothens out ups and downs.
A look at the table shows how investing regularly can fetch you more shares of a stock through rupee cost averaging. In the above example, when investing in lumpsum, the share price was Rs 20 -- meaning, you end up buying 500 shares.
Instead, if one were to invest Rs 1,000 every month for 10 months, the total number of shares purchased adds up to 520, since these were bought at different price levels and the average cost of each share comes down to Rs 19.6.
And 520 shares would definitely fetch a higher return than 500 at the end of ten months.This is the principle followed in the systematic investment plans of mutual funds. And it is something that the retail investor can follow when investing in shares too.