Does rupee cost averaging really work for SIP beyond a point? Rethink your strategy

However, as your accumulated amount grows, it’s time to reevaluate whether rupee cost averaging continues to be effective in maximizing returns. In this article, we unravel the truth and urge you to rethink your SIP strategy.

Understanding Rupee Cost Averaging:
Rupee cost averaging, a cornerstone of SIPs, is designed to average out the cost of investments over time. By investing a fixed amount at regular intervals, regardless of market fluctuations, it aims to mitigate the risk of making significant investments at unfavourable peaks. The concept is appealing and has proven successful for investors with smaller portfolios.

The Question of Effectiveness with Accumulated Amounts:
As your investment portfolio expands, it becomes crucial to critically examine the effectiveness of rupee cost averaging. Here’s why it might fall short:

Diluted impact on larger portfolios: As your accumulated amount grows, the impact of regular SIP contributions on your overall portfolio diminishes. Rupee cost averaging is most powerful when investment amounts are substantial compared to the portfolio size. It becomes essential to reassess the strategy’s effectiveness in light of this.

Let’s understand this through a case study:
Ravi has been investing Rs 10,000 per month via SIP in Nifty 50 for a long time, and as of Jan 2008, the current value of his portfolio is 10 Lacs. Whereas Raj has just started investing in the same scheme Nifty 50 via SIP with a monthly contribution of Rs 10,000 from Jan 2008. Let’s analyze their returns from January 2008 to December 2010, a period that witnessed significant market volatility due to various economic events and the global financial crisis. During this time, the market experienced both ups and downs.

Now, if you observe the return profile for Ravi and Raj during this period, it is very different. Raj generated an XIRR* (Extended Internal Rate of Return) of 24.56%, whereas Ravi only achieved 9.10%. This demonstrates that the impact of rupee cost averaging diminishes as the portfolio value becomes significantly high compared to the monthly SIP instalments.The opportunity cost of missed lump-sum investments: Relying solely on SIPs may cause you to miss out on opportunities to invest larger amounts during significant market downturns. Capitalizing on these moments by making lump-sum investments can potentially yield higher returns when the market recovers and moves upward.

Rethinking Your SIP Strategy:
While discontinuing SIPs isn’t recommended, it’s time to explore alternative strategies that adapt to your evolving investment needs. Here are two approaches to consider:

Amplify your SIP amounts: Instead of abandoning SIPs, consider increasing your regular contributions as your accumulated amount grows. By doing so, a higher proportion of your portfolio can benefit from rupee cost averaging, especially during times of market volatility.

Seizing market downturns: Rather than relying solely on regular SIPs, be prepared to take advantage of market downturns by making additional lump-sum investments. When prices are low, allocating a lump sum can potentially yield substantial gains, as historical market trends indicate recovery and long-term upward movement.

Conclusion:
As you delve deeper into your investment journey, it’s crucial to reevaluate whether rupee cost averaging truly works for SIPs beyond a certain point. By questioning conventional wisdom and adapting strategies that capitalize on market opportunities, such as amplifying SIP amounts and seizing market downturns, you can optimize the potential of your investment portfolio. Remember, staying informed, diversifying investments, and seeking guidance from financial professionals will further strengthen your investment strategy’s success. It’s time to rethink and evolve your SIP approach to unlock the full potential of your investments.

* XIRR or extended internal rate of return is a single rate of return that provides the current value of the entire investment when applied to each systematic investment plan (SIP). It is used where many transactions happen during a period. At times, one can redeem a small amount from their investments. On the other hand, investors can pause several months of investments. In such instances calculating the returns becomes easier with XIRR.

The author, Sudip Mandal, is VP and Head – Distributor Marketing, DSP Mutual Fund

(Disclaimer: The views expressed above are personal opinions. The information provided in this article is for informational purposes only and should not be considered as financial advice. It is recommended to consult with a qualified financial professional and tax consultant before making any investment or financial decisions. Mutual Fund investments are subject to market risks, and it is important to read all scheme-related documents carefully.)