Rupee Cost averaging

Suresh is about to open a Demat account. He wants to learn more about investing in the stock market. His friend Shivani, who has been an investor for many years, is an expert in the topic. He met her to learn more about the share market. He's heard of the term rupee cost averaging, but hasn't been able to understand it.

"Shivani, as you know, I was able to open a trading account and a demat account. I was curious to learn more about certain terms. I keep seeing the rupee cost average everywhere ..." Suresh says.

Suresh says, "This is the best time to grasp the concept. How to invest in stock markets is something you already know. However, volatility is the nature of the market. You can avoid the risk of the market timing by using rupee cost averaging (RCA), for short. You can reduce the average share price by investing over time rather than in lump sums.

Suresh then asks, "Where does it come in to play?" "RCA is a term that you might use to describe mutual funds or systematic investment plans (SIPs) where investments are made at regular intervals. It works like this: You buy a share today for Rs110. Its price drops to Rs 100. In the hope of a bull market, you buy another share. You now have two shares and the average price of each is Rs 105. She explains that if you sell the shares at Rs 180, your profit would be Rs 75 per share.

Can you please give me an example of rupee cost averaging and lump sum investments. Suresh says that this would help me better understand the concept.

Shivani exclaims, "Happy to oblige?" Shivani exclaims, "Now imagine that you have invested Rs 8,000 in mutual funds units or shares." It can be split equally or invested in one go.

100 units are available for purchase in month 1. For the same Rs 2000, you can also buy 111.1 units in month 2. For Rs 2000, you can also buy 117.6 units in month 3. For Rs 2000, you can buy 105.3 units in month 4, when the unit cost is Rs 19. She elaborates that if you add the four months together, you will get 434 units if you use the rupee average method.

"But, on the contrary, if a lump sum investment of Rs 8000 was made at a unit cost Rs 20, you would get fewer units (ie 400).. You can see a table I will source for your information and get an idea of rupee cost average over six months.

Suresh said, "This means that you can buy more shares when prices fall and less when they increase, thus averaging it all."

Shivani declares, "Absolutely Suresh." It doesn't really matter how much you paid for a share. The average share price at the end of your purchase is what matters. This average price will determine your returns," she says.

Shivani, thank you for explaining one of the basics of the sharemarket so clearly to me. He then asks, "What are the best scenarios where rupee cost averaging is most effective?"

Ideal scenarios for RCA

Rupee cost averaging is a great option for beginners or those who don't want to take on the risk of timing markets. Shivani also points out that if you look at the long-term, periodic investments in stocks rather than lump sums will help you achieve stable returns.

Suresh says, "If you're someone who wants discipline to be inculcated, this concept might be the right one for you." He chuckles, "That sounds a lot like me."

He exclaims, "Got it!" and then continues, "so, even if I don’t have a lot of money to invest at the beginning of my investment journey but feel confident about investing small amounts each month, rupee cost average may be a good option."

Shivani says, "Many experts believe the RCA idea works well in bear markets because falling prices make sure that the average cost falls over a time period." It could also work in a bull markets, where you can invest small amounts when prices drop, but not significantly.

Do not lose sight of the basics

"And remember, Suresh. A falling stock is a sign that the company may not be doing well. She points out that in such a situation, the stock might not rise for a while and that lowering the average share price may not be of any benefit.

"Yeah, I understand. "This would mean that I would need research the company and keep track on developments," Suresh inquires. Shivani exclaimed, "Yes," and added, "Just because you use RCA doesn’t mean that you forget other share market basics!"

"I have a trading account and a demat account. It's high time that I put into practice the basics of share market investing you just taught me. Shivani, thank you for explaining the concept of rupee-cost averaging to me and helping me learn more about how to invest in the stock market," Suresh said. "Anytime! As they continue to discuss other topics, Suresh says that there is no better time than now.