Does Rupee Cost Averaging Work in All Phases of the Market?

Rupee cost averaging is a well-known concept, especially for those involved in trading or long-term investing, particularly in mutual funds. It’s a strategy where you invest a fixed amount of money at regular intervals, regardless of market conditions. This approach helps to mitigate the effects of market volatility by buying more units when prices are low and fewer units when prices are high. Over time, it aims to lower the average cost per unit and promote consistent investment habits.

When prices are low, your fixed SIP investment buys more units or shares, and when prices are high, it buys fewer. This gradual accumulation results in a lower average cost per unit over time, mitigating the impact of market volatility.

It encourages a focus on long-term performance rather than market timing. But does it work in all market phases – uptrends, consolidations, or downtrends? In this article, we are going to explore the two phases of the market when rupee cost averaging doesn’t work in your favor.

From Bullish to Bearish Phase

Let’s examine the market movements from 2006 to 2008, before the crash. During this period, the Nifty index surged from approximately 2800 to a peak of around 6360 in 2008, before plummeting back to its initial levels by October 2008. If you sold your investments upon seeing the market fall, the following would be the result of your investment values of Rs 1000 SIP investments made every month during this period. In this phase, you experienced a bullish phase earlier and then eventually a significant downturn.

With a loss of over 31% in absolute terms or around 24% fall in your investment in terms of annualized returns, did rupee cost averaging work here? No right. It will work surely when it halts for some time at the lower levels and starts moving toward the upside; then the investment returns will be impressive.

From Upside Trend to Sideways and Finally Breakdown Towards Downside

As an investor or traders, we dislike consolidation unless it aligns with our expected directions. During consolidation, stocks or mutual funds typically remain at the same price or within a narrow range. While your fixed SIP amount accumulates units during consolidation if the breakout goes against your direction, it won’t help your investment grow; rather, it may reduce your investment value. Suppose an investor began investing on the date mentioned in the image and experienced a good rally, followed by consolidation. However, instead of continuing the trend, it eventually falls and breaks the consolidation towards the downside. Here’s how your investment value would evolve during this period.

Investors will profit when the market moves upwards, consolidates for a period, and eventually breaks out of consolidation towards the upside, continuing its original trend.

How SIP works

Conclusion

In conclusion, while rupee cost averaging is widely popular, its effectiveness can vary across different market phases. The analysis demonstrates that during a transition from a bullish to a bearish phase, rupee cost averaging may not always yield favorable results. Similarly, in scenarios where a market trend shifts from an upside trend to consolidation and ultimately breaks down toward the downside, the strategy may not prove beneficial. Hence, investors must be mindful of market dynamics and adapt their investment strategies, accordingly, considering both the potential benefits and limitations of rupee cost averaging.

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Disclaimer: This post has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.