Tuesday, June 19, 2012

Learn to like a falling market!!!

Hi Friends,

Today I shall discuss how one should take advantage of a falling market. The concept is pretty simple. It is known as rupee cost averaging.

We often hear people saying something like "Today I bought 1000 shares of Reliance@ 800. It has already come down from 1200 to 800 and it can't go down any further." Now timing the market is foolish, time consuming and almost impossible. Timing the market is an area where most investors are prone to go wrong.

Under rupee cost averaging one does not have to worry when and how much to invest. Periodic investing is done irrespective of the market conditions. Let us assume that a person had Rs 10000 today and he wanted to invest in a company A which is trading at Rs 20. He would have been able to buy 500 shares. (Scenario 1)

Instead of one time purchase if the same person were to invest Rs 1000 per month for the next 10 months, the scenario would be something like:-(Scenario 2)

Time(mths)        Fixed amt invested             Price per share               Shares Purchased

      1                                 1000                                   20                                      50
      2                                 1000                                   21                                      48
      3                                 1000                                   24                                      42
      4                                 1000                                   19                                      53
      5                                 1000                                   16                                      63
      6                                 1000                                   17                                      59
      7                                 1000                                   14                                      71
      8                                 1000                                   23                                      43
      9                                 1000                                   18                                      56
     10                                1000                                   22                                      45

    Total                            10,000                                18.86                                530

    Thus we see that in case of Scenario 2, he has purchased 30 more shares than Scenario 1 and that too at a lower cost i.e. 18.86 vis-a-vis 20. Plus the worrying bit was not there.

P.S: This should be done with a great company. If rupee cost averaging is done in case of a stock like SKS Microfinance or Koutons, you will keep on averaging and you will start posting negative feedback on my blog.

Hope this helps,

Vivek

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