Why is Rupee Cost Averaging important?

As an investor, you probably want to keep making investments on an ongoing basis but find it hard to set aside large sums. Pretty much every investor struggles with this at some point or the other. That’s where Rupee Cost Averaging (RCA) comes in.

What is Rupee Cost Averaging?

Rupee Cost Averaging (RCA) is an investment strategy that allows investors to invest a small, fixed sum of money at regular intervals. It helps to:

1. Minimize the impact of volatility: This process of buying into the market for fixed amounts over a period helps investors to stay invested. Buying regardless of the market price and ensuring that you don’t have to time the market helps absorb the impact of market fluctuations.
2. Inculcate disciplined investing: Since investors invest a fixed amount at regular intervals, they are not as tempted to make impulsive decisions.

A definition of Rupee Cost Averaging

So, to sum up, RCA is a strategy that lets investors choose to commit to investing a fixed rupee amount at regular intervals. They can choose to invest in a particular share, bond, mutual fund, or anything else. The choice is theirs in that respect.

How Rupee Cost Averaging works in investment

The rupee investment amount is fixed, so the investor can get more units when the market is down. On the other hand, they get fewer units when the prices are high. In the long run, this ensures that investors are somewhat insulated from market fluctuations. Because the profits and losses average out.

Differences between Rupee Cost Averaging and lump sum investments

In RCA, the investments are made in multiple small installments over a period of time. On the contrary, a lump sum investment involves investing in one large installment.

Since RCA is spread across a longer period, price fluctuations balance out. But with lump sum payments, investors are at a disadvantage if they enter when the price is high.

Benefits of Rupee Cost Averaging

As may be evident by now, rupee cost averaging has several advantages. Let’s list them out for the sake of additional clarity.

1. Smoothes out market volatility

Since the rupee amount of each investment is fixed, when prices are lower, investors buy more units of the security. And when prices are high, they buy a lower number of units. In this way, the price is evened out.

2. Helps avoid emotional investing decisions

RCA encourages the adoption of a disciplined approach. That means there is no scope for emotional investment decisions.

3. Increases investment over time

Fresh investments continue to be made across the chosen time period. So the number of investments keeps increasing even when the markets are volatile.

4. Reduces the impact of market timing

As the investments are made continuously, the prices even out. So in the long term, the timing of the market is not of great consequence.

Implementing RCA in investment

Now that we know what RCA is and what the benefits are let’s see how its implementation works. The implementation is very simple, as you will see below.

How to incorporate rupee cost averaging into an investment strategy

The incorporation of RCA involves the following steps.

1. Set a regular investment schedule: Calculate the investment amount and its periodicity.
2. Choose the investment security: Identify the ideal share/bond/mutual fund, etc., that you wish to invest in. You could read our other articles on these topics while researching your options.
3. Set up an automatic process: This can be done by giving standing instructions to your banker or online in the mutual fund company’s portal. Automating the process will make your investments much more systematic and easy to handle.
4. Periodic monitoring: Determine if the investment is meeting your objectives and timeframe.

Factors to consider when using Rupee Cost Averaging

Before implementing RCA, ask yourself these questions in relation to these factors to ensure it is the right option for you.

1. Investment objective: What is the goal, its quantum, and when do you need the corpus? How much of a risk are you prepared to take?
2. Market conditions: How are the volatility, interest rates, and/or market conditions?
3. Time horizon: How long are you planning to stay invested? (RCA is more suited in medium- and long-term scenarios.)
4. Quantum and periodicity: Is the installment amount realistic and sustainable? And the period?
5. Diversification: Has your investment plan factored in the diversification needs of your portfolio?

Setting up an automatic investment plan using Rupee Cost Averaging

After asking yourself these questions, if you still want to ahead, here’s how you could go about it.

1. Ensure that the amount is realistic and manageable.
2. Set up an automatic system with your bank or brokerage house.
3. Many investors sync the RCA plan with their salary dates to ensure that there will be no slips in remittances.

Managing the investment portfolio using Rupee Cost Averaging

In relation to deciding how much you could safely invest, you should do the following.

1. Decide on the amount per installment. Calculate it, taking into account all your financial commitments.
2. Choose the frequency. Many investors find it convenient to invest each month on salary day.
3. Set up automatic remittances. The popular ways are through standing instructions with banks or brokerage houses.

Rupee Cost Averaging vs. other investment strategies

In this section, we take stock of all that we have been discussing so the process of comparing RCA with other strategies is easier.

A comparison with other investment strategies

With lump sum investing, a large amount is invested in one shot. One has to time the market because the value of your investment depends on the current market rate. This strategy is great only when the market performs well.

RCA, with its periodic pattern, is thus better insulated against volatility. Knowing when to invest is complex, and RCA minimizes the uncertainty of timing investments. Active management involves market research, analysis, undivided attention, and financial resources. Investors also need to be on their toes constantly to leverage investment opportunities. RCA spares the investors all this hassle.

However, there is the possibility of lump sum investing going right. When this happens, it can yield better returns if you’re okay with the risks.

Advantages and disadvantages of Rupee Cost Averaging

There are various pros and cons of all investing strategies, including RCA. Here, we assess how RCA holds up against the other options.

In other investment strategies, the timing of the investment is essential, and price-volatility risks are high. But in RCA, these are minimal.

In rising market conditions, your RCA investment will result in smaller holdings. This means lower returns. Meanwhile, the transaction costs stay high due to the frequency of investments.

Understanding the risk and reward trade-off of Rupee Cost Averaging

RCA protects the investor from price volatility but doesn’t have the potential for greater returns compared to a lump sum investment when the market is down. In a constantly falling market, RCA will face losses.

Determining the suitability of RCA for individual investment goals

Rupee Cost Averaging works better when certain conditions are met. For instance, it depends on the following factors.

• Investment horizon: RCA is better suited for long-term horizons.
• Risk tolerance levels: As the investments are spread over a long time frame, RCA is a low-risk strategy.
• Volatility: The RCA strategy is geared to handle price fluctuations.

Conclusion

RCA is a good strategy for long-term investors who are risk-averse. It creates investment discipline and helps reach long-term investment goals with minimal effort.

FAQs