The objective of investing in different investment instruments such as mutual funds and equity with lower risk exposure can be met to some extent using rupee-cost averaging (RCA). Rupee-cost averaging is a technique that requires you to invest a fixed sum of money in some of the available investment options on a regular basis. Taking this stance, free you of the need for timing the market i.e. on deciding the time to make a particular investment as well as the time to exit from it.
As such lump sum investment in safe instruments such as fixed deposits or government bonds pose no risk to the investment made. Conversely, risk i.e. inherent in other investment options, including equities and mutual funds, could be minimized using the RCA technique. So, regardless of the stock market condition as well as the economic outlook, investor can park in the funds without worrying on even the amount of fund that they need/ought to deploy in a particular investment.
How RCA applies to mutual fund investments?
In case of mutual funds, regular investment of a certain fixed sum can fetch you more fund units in the case when NAV of the fund is down by some points or otherwise. Say when you park Rs. 1000 in a certain month, NAV of the fund was Rs. 20, the number of units then allotted to you would be 500 and when you again invest a same sum of Rs. 1000, you can be allotted higher or lower number of units depending on the NAV price at that time.
Further, the general tenet holds that over the term of the investment, investor generally end up realizing higher units as otherwise in the case of one time investment made. Further, more number of units will fetch higher returns.
So, in all a regular investment of some pre determined sum helps an investor to average the cost of the investment over the term of the investment. And it is on the average cost of investment that your returns are based instead of the cost that you incurred for each of the mutual fund unit so you presumably earn better returns.
In case of equities, rupee cost averaging principle or technique requires you to buy fixed number of share without paying heed to the price level. However, investor is required to buy more number of shares at a lower price and vice-versa to lower the average cost/ share. Initially, the technique can result in losses with market trending southwards, nonetheless you with your investment can gain more number of shares at the current price level that will help you offset any losses in the future term. Also, decreased average cost per share will enable the investor to realize higher returns in the future term.