Rupee Cost Averaging - An ideal investment strategy for Sri Lanka

Sri Lankan Stock market has seen many changes since it's inception. We also have seen many strategies in play that have evolved overtime. But quite a number of investors are in the habit of buying when the prices are down, or in a downward slope. Also the habit of buying and not cutting losses has left many players bewildered not knowing the best course of action. Also the market has no new products, other than buying to sell, as it will take time to see the evolution of shorting and covering. Therefore BUY and HOLD has been a habit of the players more than a strategy.

BUY and HOLD is not a bad habit, but how it's done or the timing of entry are things that many have not planned. Investing in the stock market is an art. This Art needs a plan. But getting used to a plan or writing down a plan and sticking to it is a very rare occurrence. Therefore RUPEE COST AVERAGING (RCA) can be one of the ideal platforms to help you in planning and disciplining the habit of investment.

Basic Rupee Cost Averaging
The basic form of RCA is that you decide in investing a fixed amount of Rupee Value on a regular interval.
The idea is that when you invest a fixed value, then you buy more stocks when the price is low, and a few when the price is high. This way you cut down on emotional buying, which is something that many do when they average down. Also you plan the installment or the fixed value. As such you do not wonder how much to put in at every given time.

A basic example can be as follows:

Say you decide to put in Rs. 10,000.00 every time you want to buy at the price you feel attractive or justifiable to buy the stock at.

1st Purchase - Rs.10,000@10.00 = 1000 shares.
2nd Purchase - Rs. 10,0000@12.00 = 833 shares.
3rd Purchase - Rs.10,000@9.00 = 1111 shares.
4th Purchase - Rs.10,000@8.00 = 1250 shares.
5th Purchase - Rs.10,000@6.00 = 1666 shares.
After Rs. 50,0000.00 investment you have 5860 shares at an average of Rs.8.53 per share.

RCA can be used effectively in Sri Lanka
In the Sri lankan market RCA is very useful if you decide to buy a stock at very attractive and cheap in valuations, in terms of PE, PBV or Div yield. Present valuations in many stocks are such that a planned method such as this is the most suitable. This is also useful when you pick stocks for the Long term, especially if you are determined to retire Rich, and live a satisfying life before and after retirement.

The trick in this strategy is to invest an amount that you can conveniently afford to put aside for the long term. That is the most important decision you have to make in this method.

RCA is your servant and not vise versa

Also you can buy into many stocks in order to diversify your portfolio by using this technique. People who are used to follow this strategy get carried away by thinking you need to put your money only to 1 stock, or should keep on pumping money when the prices are moving in an uptrend. You do not need to be a servant to the strategy instead the strategy must be your servant.

The wrong approach which should not be followed 

The theory says that you need to put equal installments. As such this has been un ethically marketed  to get clients to invest monthly or quarterly, thereby committing clients to invest for the sake of making it an avenue to bring regular turnover to the brokerages. This is completely against the strategy. The importance of this strategy as explained is to buy more at lower prices, and buy less at higher prices. Because in a lump sum investment you can decide in buying a stock as you feel the price is right, but the stock can drift down further. In that situation, instead of a lump sum you can keep adding more shares even if the prices fall from the point you've figured out the fair price.

Example :

If the fair price is 20. If you put in Rs. 100,000.00 at once you will get 5000 shares. But if the price start falling below 20, you will not have a chance of buying more without infusing more cash. But if you decide to break that lump sum down to 20, 10, 5 or 4 installments, then you can keep on adding more shares when the prices fall. Say if you've decided to break it into 4 equal installments of Rs. 25,000.00. Then if it falls to 18, 16, 14 and 12 then you will end up owning 6820 shares. Also your average price will be 14.70.

Therefore if you want to invest with discipline, to a plan and to your advantage in reducing the average cost this will be one of the basic and simple strategies. But there is no point following this when the prices are rising above realistic valuations.

In my next post I will touch on the Rupee Value Averaging which is a bit advanced than the RCA but worth the knowledge.