In the first half of this year, the BSE Sensex briefly kissed the 30,000-point level. Now, though, it’s been fluctuating between 25,000 and 26,000-marks. This has been a drastic correction in the market, predominantly led by lower-than-expected earnings announcements and global cues. That said, analysts continue to remain positive about the long-term future of the Indian markets. In such a falling market, it is quite possible that some of your stocks may see regular Red marks. So, how do you make the best of this situation? The answer lies in rupee-cost averaging.
Let’s explain with an example. Suppose you bought a share today for Rs 120. Tomorrow, the cost of the share falls to say Rs 100. You again buy another share, confident that the future is bullish. Now, you have two shares. Your average cost of buying this share is Rs 110. So, tomorrow, if you sell the shares at say Rs 200, you pocket a profit of Rs 90/share. This is called rupee-cost averaging.
It is difficult to time the market. So, the concept of rupee-cost averaging helps in reducing your cost of ownership during periods of market volatility/corrections.If you had invested all your money and bought shares at Rs 120, your final profits would be much lower (Rs 80/piece). You can also use the concept of averaging while selling your stocks at continuously higher rates.
Experts suggest that the concept of rupee-cost averaging is best for bear markets. The falling prices ensure your average cost becomes lower over time. This is why it is said that falling markets can be a gold mine of opportunities.
A rupee-cost averaging can be used in Bull markets too. This is when the share prices rise continuously over a period of time. In such cases, analysts usually suggest to invest in a lump sum at the cheapest price possible. But even in such bull markets, regular falls can happen, though these may be on a very small scale. So, you can invest small chunks of your money at such dips. This will help curb your average cost. Even if the prices increase tomorrow, your average cost would be lower.
The concept of rupee-cost averaging can be great to maximize your profits in the long-term. But, it depends on the stock’s future value. If a stock continues to fall, there could a chance that the company is facing troubles. In such a case, it is unlikely to rise in the future. This means, there’s no point in lowering your average cost. Cut your losses and sell the stock. So buy at lower rates only and only if you are confident about the stock’s future value. Investors should avoid debt-burdened companies while practicing rupee-cost averaging.
There are many investors who take the concept of rupee-cost averaging one step further. Instead of investing a fixed amount regularly through market cycles, investors follow the value-cost averaging model. In this model, you first fix your goals – say a rise of Rs 500 per month. So, your total cost (portfolio value) should rise from Rs 200 to Rs 700, 1200, 1700 and so on every month. Depending on the market, you invest to meet this average cost. So, if the market falls, you buy more; if the market rises, you buy less. This, however, requires active monitoring.
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