How does rupee cost averaging benefit mutual fund investors?

If you have been investing in equity mutual funds through a systematic investment plan (SIP), then you would have surely heard of a concept called rupee cost averaging (RCA). RCA helps you catch lower price points in an investment through regular investing.

May 15, 2018 05:05 IST India Infoline News Service

If you have been investing in equity mutual funds through a systematic investment plan (SIP), then you would have surely heard of a concept called rupee cost averaging (RCA). For example, if you spread your investments across 12 time periods in a year, then you are likely to catch lower price points; this will reduce your overall cost of holding the fund.

RCA benefits equity fund investors in four different ways.
  1. It reduces your overall cost of holding in volatile markets
One can argue that you are better off investing in lumpsum amounts in a perpetual bull market and hold on to them. However, two problems arise here: Firstly, nobody knows the bottom; hence, the question ‘where to buy?’. Secondly, bull markets generally last for 2-3 years in a span of 10, but you need to continue investing throughout this 10-year-period. The example below will illustrate how RCA works in your favor.

Month Lumpsum Alpha Fund NAV Monthly SIP Units Allotted Cumulative Units
Jan 2017 Rs1,20,000 invested in Alpha Fund on January at NAV of Rs25 allotting 4,800 units at the start of the year 25.00 Rs10,000 400.00 400.00
Feb 2017 26.20 Rs10,000 381.68 781.68
Mar 2017 25.15 Rs10,000 397.61 1,179.29
Apr 2017 24.00 Rs10,000 416.67 1,595.96
May 2017 23.25 Rs10,000 430.11 2,026.07
Jun 2017 22.15 Rs10,000 451.47 2,477.54
Jul 2017 21.25 Rs10,000 470.59 2,948.13
Aug 2017 20.40 Rs10,000 490.19 3,438.32
Sep 2017 22.30 Rs10,000 448.43 3,886.75
Oct 2017 22.50 Rs10,000 444.44 4,331.19
Nov 2017 23.25 Rs10,000 430.11 4,761.30
Dec 2017 23.50 Rs10,000 425.53 5,186.83
Lumpsum Units NAV Lumpsum Value SIP Units Allocated Closing SIP Value
Year-End 4,800 23.50 Rs1,12,800 5,186.83 Rs1,21,891
 
As can be seen in the above table, the lumpsum investor is sitting on a loss at the end of the year, while the SIP investor acquired more units during the year due to the power of RCA. That is how RCA makes volatility work in favor of the SIP investor.
  1. SIP instills investing discipline
In the long run, investing is less about great stock selection and more about discipline. The longer you successfully invest a fixed amount on a regular basis, the more wealth you are going to create over a longer period. The table below captures how the wealth ratio goes up drastically by maintaining disciplined investing over a longer period of time.

How a SIP of Rs10,000 per month at 15% CAGR generates wealth over time
Particulars 5-Year SIP 10-Year SIP 15-Year SIP 20-Year SIP 25-Year SIP
Monthly SIP Rs10,000 Rs10,000 Rs10,000 Rs10,000 Rs10,000
CAGR Returns 15% 15% 15% 15% 15%
Total Invested Rs6 lakh Rs12 lakh Rs18 lakh Rs24 lakh Rs30 lakh
Final Value Rs8.97 lakh Rs27.87 lakh Rs67.69 lakh Rs1.52 crore Rs3.28 crore
Wealth Ratio 1.495 times 2.323 times 3.761 times 6.333 times 10.9333 times

The power of discipline in investing is a result of RCA. As the time frame of this discipline increases, you can see the wealth ratio also going up substantially.
  1. It saves you from having to time the market
It is not only hard to time the market and even more impossible to do so on a constant basis. Anyone who says that he can catch the tops and the bottoms of the market is either a God or a liar. What RCA does is that it saves you the hassle of trying to find the bottom and the top of the market. It has also been observed that market timing does not really add too much value to your returns over longer periods of time. Instead, if you continue to invest in equities in a disciplined manner, then the impact on your wealth is going to be much greater. That is what RCA helps you to achieve.

At a more practical level, the reason RCA works is that it synchronizes with your inflows. Hence, you are not forced to terminate your SIPs in the middle. This is one of the most important reasons why RCA is successful!

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