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Mutual Funds - Articles of Interest

Rupee Cost Averaging

Stock markets world over are characterised by ups and downs. Predicting right moment to enter and exit the market consistently is virtually impossible. Best of fund managers also find it difficult to predict stock markets. This unpredictability is both an opportunity and threat depending upon how you use it. Here is a proven investment strategy that attempts to take advantage of this volatile nature of the stock markets. This strategy is called Rupee Cost Averaging.

Simply put, Rupee Cost Averaging is a disciplined investment practice that takes the guesswork out of "timing" the markets. This strategy involves investing a fixed amount in the same investment at regular intervals - say, every month or every quarter. The essence of this strategy is that more units are purchased automatically when prices are low and fewer units when prices are high. Over time, this results in the average cost per unit - the money you pay - being lower than the average price per unit.

How It Works

It is important to note that although Rupee Cost Averaging eliminates the guesswork involved in market timing, it does not guarantee a profit or guarantee against loss in a declining market. However, with Rupee Cost Averaging you avoid investing too much when the market is high or too little when the market is low.

How To Make It Work For You?

  • Decide on an amount that you are comfortable investing regularly over a period of time. (Any amount say from Rs. 2000 onwards)
  • Choose how often you want to invest, say, monthly or quarterly.
  • Maintain a long-term perspective. Rupee Cost Averaging works best over extended period of time.
  • Invest regularly; do not be influenced by short-term fluctuations in the markets.

The Power of Compounding

Inflation can steadily erode the value of your income. However, long-term investing can provide returns that outpace inflation-through the power of compounding.

Year after year, any money that you invest may earn interest, dividends, or capital gains. When you re-invest those earnings, they help generate additional earnings; those additional earnings help generate more earnings, and so on. This is called compounding.

For example, if an investment earns 8% per year and these earnings are re-invested annually:

  • After one year, your total return will be 8%
  • After five years, your cumulative total return will be 47%
  • After 10 years, your cumulative total return will be 116%
  • Best of all, the sooner you begin investing, the greater the compounding effect

Consider the example of Chhaya and Punit, both 65 years old. They worked for the same company for 35 years and both invested in the same managed fund.

  • Chhaya started investing at age 30. She invested Rs. 1,000 each year for ten years and earned 8% per year. Then she stopped contributing. Her investment continued to earn an 8% annual return. When she reached age 65, her Rs. 10,000 had grown to Rs.107,148.*
  • Punit didn't start investing until age 40 and then invested Rs.1,000 each year for 25 years. He also earned 8% per year. At the end of the period, his Rs. 25,000 investment was worth Rs.78,954.

As you can see, although Chhaya contributed to her investment for 15 fewer years than Punit and invested Rs.15,000 less, she accumulated Rs. 28,194 more than Punit-simply because she started investing ten years earlier.
(This example is for illustration only. Your returns may differ.)