When you invest a fixed amount regularly, you end up buying more units when the market is down (lower NAV) and fewer units when the market is up (higher NAV).
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Systematic Investment Plan or SIP is a method of investing in mutual funds instruments in a disciplined manner. Instead of making a lump sum investment, investors commit to investing a fixed amount of money at regular intervals (usually monthly) into the chosen mutual fund scheme. For example, if an investor decides to invest Rs. 5,000 every month in a mutual fund through SIP, they will buy units of the mutual fund worth Rs. 5,000 at the prevailing Net Asset Value (NAV) on the specified date each month. As the NAV fluctuates over time, the investor gets more units when the NAV is low and fewer units when the NAV is high, which leads to rupee cost averaging.
Rupee Cost Averaging
Rupee Cost Averaging (RCA) is not an investment technique by itself but rather a result of the SIP approach. It is a strategy that helps investors deal with market volatility and potentially reduce the impact of timing the market.
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The basic idea is that when you invest a fixed amount regularly (as in SIP), you end up buying more units when the market is down (lower NAV) and fewer units when the market is up (higher NAV). Over time, this process averages out the cost of units purchased. As a result, investors don’t have to worry about trying to time the market to get the best entry point, as they are continuously investing regardless of market conditions.
Rupee Cost Averaging In SIP Example
Here’s how rupee cost averaging works:
Fixed Investment: With RCA, you invest a specific amount of money at regular intervals, regardless of the mutual fund’s current unit price. For example, you might decide to invest Rs 5,000 in a mutual fund every month.
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Purchase More Units at Lower Prices: When the mutual fund’s unit price is lower, your fixed investment amount will buy more units. This means that during market downturns or when the mutual fund’s price is low, you will automatically buy more units for the same amount of money.
Purchase Fewer Units at Higher Prices: Conversely, when the mutual fund’s unit price is higher, your fixed investment amount will buy fewer units. This happens during market upswings or when the mutual fund’s price is high.
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It’s important to note that while rupee cost averaging can be a useful strategy, it does not guarantee profits or completely eliminate the risk of investing in the stock market. It is still subject to market fluctuations, and the performance of the mutual fund will ultimately determine the returns on your investment.
Before investing in index mutual funds or any investment product, it’s recommended to carefully review the fund, performance history, expense ratio, and consult with a financial advisor to ensure it aligns with your investment goals and risk tolerance.
