How Does Rupee Cost Averaging Benefit Mutual Fund Investors?

17th June 2021 - 05:23 pm

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.

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.

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.

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!