SIP – understanding Rupee Cost Average

SIP works on the principle of rupee cost averaging. What this means is that the average costs of units bought is always lower than the average market price of units.

Let’s understand the concept of rupee cost averaging, bringing down the average cost, with the help of an example –

Suppose you decide to buy 10 Kg of apple every month, whatever may be the cost
Price of apples in Jan – 20/- per Kg
Your Cost 20 x 10 = 200/-
Price of apples in Feb – 40/- per Kg
Your Cost 40 x 10 = 400/-
Total apples bought 20 Kg
Total Cost 600/-
Your Average Cost = 600÷20 = 30/-

Now, you decide to spend a fixed amount of 200/- every month to buy apples whatever may be the price of apple (This is the case of SIP)
Price of apples in Jan – 20/- per Kg
You buy 10 Kg
Price of apples in Feb – 40/- per Kg
You buy 5 Kg
Total apples bought 15 Kg
Total Cost 400/-
Your Average Cost = 400÷15 = 26.66/-

Same thing happens when you buy units through SIP. Since, our monthly investment amount is fixed, we automatically buy more units when prices are low and buy fewer units when prices are high. This automatically brings down our average costs than the average market price during the period. So, eventually when unit price soar, investors get dual benefit of higher unit prices and lower average cost.

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