Did you know that as of August 2022, there are a total of 5.72 crore SIP accounts active in India? This only goes to show the popularity that this route of investment enjoys in the country. A Systematic Investment Plan (SIP) makes investments more accessible by allowing you to start your wealth creation journey by investing as little as ₹500 a month. In fact, you can use an online SIP calculator to check how much you should invest regularly to achieve your financial goals. This will help you make informed financial decisions.
But SIPs are a long-term investment. They reap the maximum benefits when you let your money to work for you over the years. This is because of rupee cost averaging.
What is Rupee Cost Averaging?
When you invest in mutual funds, your money is used to buy you units of the fund (almost like you would buy shares of a company). Now, the price of these units fluctuates due to several reasons. For instance, if the fund you’ve invested in is focused on equities, the price of the fund’s units (net asset value or NAV) would depend on how the stock market or the sector that the stocks it invests in are performing.
So, when you invest in this mutual fund through the SIP route, your investment will buy you a different number of units each time, based on whether the NAV has risen or fallen. When the market is down, you can buy more units and vice versa.
When you invest for the long-term, the impact of these fluctuations gets smoothened out because the price at which you’ve bought the units will average out. For example, let’s say you invest ₹10,000 over 4 quarters in a mutual fund, such that you’ve invested a total of ₹40,000 over a period of one year. Through this time, the NAV of the fund has fluctuated from ₹200 to ₹150, then ₹100 and finally ₹300.
So, you would have been able to buy 50 units in the first quarter, 66.67 in the second quarter, 100 in the third quarter and 33.33 units in the last quarter. You’ve now ended up with a total of 250 units. So, the average NAV that you’ve invested at works out to ₹160. This is much less than the price you paid for almost two-thirds of the units you’ve bought. Rupee cost averaging works this way regardless of whether you invest in mutual funds online or offline. You can get an estimate of the expected returns by using an SIP calculator.
Who Benefits from Rupee Cost Averaging
The longer you stay invested, the more time you give for rupee cost averaging to work in your benefit. This is because prices fluctuate more significantly over a span of 5-10 years than they would in a single year. So, rupee cost averaging will work best for investors with a longer investment horizon.
Also, those who invest at regular intervals, rather than making a lump sum investment, will benefit. This is because periodic investments allow you to make the most of price fluctuations. You can use a mutual fund SIP calculator to check the returns you can expect with your chosen timeframe and investment capital.