Rupee Cost Averaging is a term commonly associated with Systematic Investment Plans (SIPs), an approach where the cost of mutual fund schemes is averaged out through systematic distribution. One purchases more units when prices are low and vice-versa and although it does not guarantee profit but may help in cutting losses in case of short term market fluctuations as well as the total costs.
What is Rupee Cost Averaging – How it Works
SIPs are a mode of payment that spread out the entire investment amount over the investment duration by distributing it into periodic installments. The price of mutual fund units keeps changing on the basis of Net Asset Value (NAV) that day. With a fixed installment every month, when prices are high, the units purchased are less and it is more when the prices are low. This helps in balancing out the costs as the units will be purchased not on one given day (when the unit price may be high) but throughout the investment tenure (the unit price keeps changing).
Most of the investors cannot decide when to enter the market and they may end up investing more and redeeming less. Although it is suggested to buy more when the units are cheap so that the investors can gain more capital returns, at times investors could end up doing the opposite. More units of highly demanded MF schemes are purchased which may give good returns but the investment cost will also be high. In case the fund undergoes a slump and the investor redeems it, s/he ends up losing more than gaining. But in SIP, as you do not invest the lump sum at once, Rupee Cost Averaging is a great advantage that also acts as a shield to market volatility.
Example of Rupee Cost Averaging in SIP
Let’s consider a case where an investor decides to invest ₹12,000 as a lump sum in a MF Scheme and s/he invests on January 1 to stay invested for an year. Suppose, the unit price that day is ₹27, then the total units purchased by the investor is 444.44 or 444.45 approximately. Now, for instance if this ₹12,000 investment is done through SIP mode for an year and instead of a down payment, there is monthly installment of ₹1,000 for 12 months/1year. Let’s say the money is invested on the 1st of every month.
| Date & Month | Amount Invested/SIP Amount (₹) | Single Unit Price | Units Purchased |
| January 1 | 1000 | 27 | 37.03 |
| February 1 | 1000 | 20 | 50 |
| March 1 | 1000 | 18 | 55.55 |
| April 1 | 1000 | 25 | 40 |
| May 1 | 1000 | 30 | 33.33 |
| June 1 | 1000 | 16.5 | 60.60 |
| July 1 | 1000 | 22 | 45.45 |
| August 1 | 1000 | 26 | 38.46 |
| September 1 | 1000 | 19 | 52.63 |
| October 1 | 1000 | 20.5 | 48.78 |
| November 1 | 1000 | 24 | 41.66 |
| December 1 | 1000 | 28 | 35.71 |
| Total | 12,000 | 276 | 539.2 |
You can see we have purchased more units through SIP than in Lump sum with the same amount. Secondly, the overall cost in SIP is lower than that of the lump sum as the average cost of unit price is ₹22.26 (Total Amount/Total Units).
Lump sum SIP
Amount = ₹12,000 Total Amount = ₹12,000
Units Purchased = 444.44 Units Purchased = 539.20
Unit Price = 27 Unit Price/Average Cost = 22.26
An added benefit of SIP, apart from the rupee averaging cost and a chance that you may buy more units than in lump sum, is the Power of Compounding. Other than this monthly installment, the returns gained on the previous amount will also be reinvested with the new installment.
Read More – Which is the better investment mode – Lump Sum or SIP?