Many of us want to invest into stock markets, mutual funds and ULIPs but always have this question in mind.
- Are the markets too high now?
- Is this the right time?
- Will I gain if I wait for a while longer?
Rupee Cost Averaging helps to eliminate the risk of a falling or rising market. It averages the cost of the units you buy so that you can manage the cyclical up and down market movements over time.
Rupee Cost Averaging is best understood with an example.
Let’s take Guru who has Rs. 60,000 to invest into a ULIP that he wants to buy for building up a wealth fund for himself over the next 8 years. His agent comes to him and says, “Sir, invest it right now – the markets are going to go up and you will earn handsome returns.” But Guru is an intelligent person and does not take whatever is told to him at face value. He is not convinced with what his agent says – what if the agent is saying this only so that he gets his entire policy commission in one shot? He wants to understand the pros and cons of investing it yearly and if there is a better way. Let us look at the options that Guru has.
- Invest Rs. 60,000 right away in one shot
- Invest Rs. 30,000 now and then Rs. 30,000 after six months
- Invest Rs. 5,000 every month for 1 year
Let us also assume that the market is moving up and down (like it always does), and therefore we are never sure which is the best time to buy.
T0 understand Rupee Cost Averaging, check the table below.
(Click anywhere on the table to view it full screen)
All the 3 options are shown above. To explain Rupee Cost Averaging, I will take you through each of them now.
- The markets move up and down – at the highest point, the value of each unit that Guru buys is the highest (Rs. 26.66) and at the lowest point, it is the lowest (Rs. 17.50)
- In each case the total investment is Rs. 60,000.
- To see which option turns out to be the best, we have assumed that 8 years later on Jan 1, 2022, when Guru wants to withdraw, the unit value is Rs. 61.55.
Option 1 :
The units can be bought in one shot. Guru can get 2,524.19 units @ average Rs. 23.77. When he sells after 8 years, he can get Rs. 1,55,364.
Option 2 :
Since Guru can split the purchase into 2 parts and the markets were a bit lower in Jul than in Jan, his average unit cost can be lower @ Rs. 23.26 and so he can get slightly more units, i.e. 2,579.62 units. When he sells it after 8 years, he can get a better value, i.e. Rs. 1,58,775.
Option 3 :
Guru can split the Rs. 60,000 into 12 equal monthly parts of Rs. 5,000 each. The no. of units now depend on the way the markets move. When the markets go up, the no. of units that can be bought is lower, and when it goes down, Guru can get more no. of units. e.g. refer to the 2 grey color rows for Mar and Sep. In Mar, the markets are highest, so the unit rate will be the highest (Rs. 26.66) and so the no. of units Guru can get for his Rs. 5,000 investment is lowest (187.55). But in Sep, the markets are lowest, so the unit rate will be the lowest (Rs. 17.50) and so the no. of units Guru can get for his Rs. 5,000 investment is the highest (285.71).
So LESS UNITS can be bought at HIGHER RATE when markets are HIGH, and MORE UNITS are bought at CHEAPER RATE when the markets are LOW. Since more units come at lower rate, the average unit price will be much lower, and so the no. of units overall will be much higher.
Guru can therefore get 2,716.47 units in Option 3 at the cheapest average rate of Rs. 22.09! When he sells it after 8 years, he will get Rs. 1,67,199 – the highest profit!
This concept of averaging cost for getting a benefit in unpredictable markets is called Rupee Cost Averaging.
Rupee Cost Averaging gives lower average rate for your units. i.e. it gives you more units for the same investment made. It is that simple.
Ideally, it would have been good to invest everything when the market is at its lowest point, i.e. @ Rs. 17.50, but we need to be God to be able to predict that. In Jan 2014 when we begin our investment, we will never know when the lowest point will reach because we cannot predict the market. So for lesser mortals like you and me, Rupee Cost Averaging is God’s gift for maximizing our returns. 🙂 And yet so few of us take benefit from it!
So whenever you invest in ULIPs, Mutual Funds or Stocks, use the concept of Rupee Cost Averaging. Invest into ULIP only with monthly premiums (whatever your agent says), into Mutual Funds through Systematic Investment Plans (SIPs) and in stocks buy small amounts over time rather than everything in one shot.