The primary use of Rupee Cost Averaging is while investing in mutual funds. Rupee Cost averaging originates from a similar practice, Dollar Cost Averaging, both of which have similar functions and purposes. In both, the primary function is to reduce the volatility of market, and both depend on periodic investment.
Rupee Cost Averaging is an investment strategy that focuses on periodic investment in a targeted asset, for a fixed amount in an effort to reduce volatility.
The basic premise of the strategy is in the fact that prices of assets, in this case prices of units of mutual funds keeps fluctuating. The idea is to invest a particular amount, and not focus on the units of investment.
Rupee Cost Averaging Example:
Suppose you invest Rs. 10,000 in mutual funds every month. In the first month, you bought 100 units of Rs. 100 each. In the second month, you invest Rs. 10000 again. However, the price of each unit has risen to Rs. 200, so you manage to buy only 50 units. In the third month, the price has fallen to Rs. 50, so investing Rs. 10000 gets you 200 units of the asset.
At the end of the fourth month, the asset stabilizes with a value of Rs. 120, which is 20% return on your original NAV. However, since the prices keep fluctuating, that is not your actual return. On selling all of the assets at Rs 120, there are three scenarios:
1.On 100 units bought at Rs. 100, you get a profit of Rs. 2000 (20 * 100)
2.On 50 units bought at Rs. 200, you make a loss of Rs. 4000 (80 * 50)
3.On 200 units bought at Rs. 50, you make a profit of Rs. 14000 (70 * 200)
In entirety, that amounts to a profit of Rs. 12000.
Basically, what Rupee Cost Averaging does is balance your investment. You see, because you always invest a fixed amount irrespective of prices, when the market is high, the unit investment decreases. This helps, because in investing, Benjamin Graham says, profits are never made in buying during high markets at expensive prices. It considers the eventuality of the price falling and stabilizing to its original mean value.
During bearish markets, the investment units are increased due to the same amount being invested. This, as visible from the aforementioned example, is where majority of profits come in, by buying in cheap. Needless to say, it works on the same principles and assumes that the bearish and bullish trends of the market stabilizes to make profits.
In its simplicity, this strategy covers a lot of aspects about good investment practices. It makes investment a habitual phenomenon, it limits the amount of investment to a comfortable sum and it accounts for market trends.
Also note that Dollar Cost Averaging, from which Rupee Cost Averaging has emerged, has a probabilistic success rate of 66%, as mentioned by various scholars.