This article emphasizes the multiple benefits of cost averaging, and describes how to practice it.

So, can anything be done to reduce the risk of timing? Yes - through a very simple concept called Cost Averaging, or Rupee Cost Averaging.

What is Cost Averaging?

Cost Averaging is a procedure through with you can eliminate the effect of timing the market, and thus, can significantly reduce the risk associated with market volatility. In fact, using Cost Averaging, you can actually benefit from market volatility!

Sounds strange? Maybe! So let's know more about Cost Averaging, and find out how it can be implemented.

Methodology

In cost averaging, you make fixed, periodic (usually monthly) investments, irrespective of the level of the market.

This means that you invest a fixed amount in an asset every month, totally disregarding the price of the asset. The benefit is that when the price of the asset is low, you would get more of it for the same amount, whereas if the price of the asset is high, you would get less of it for that amount.

The result - you would buy more of it when the price is low, and less of it when the price is high! Thus, the average price of acquisition for the asset gets reduced. And remember, this happens automatically - you just have to ensure that you invest the same amount every month in the same asset!

Let's understand this using an example.

Let's suppose you decide to invest Rs. 5000 every month in shares of ITC. You start investing on 7th January, and invest Rs. 5000 on every 7th.

Amount = Rs. 5,000
Period = 1 Month
Asset = Shares of ITC

In the first month, the price of each ITC share is Rs. 200. So, you end up buying 25 shares (Rs. 5000 / 200 per share = 25 shares). Your cost of acquisition is Rs. 200 per share.

In the second month, the price of each ITC share is Rs. 190. So, you end up buying 26 shares (Rs. 5000 / 190 per share = 26 shares). Your cost of acquisition is Rs. 190 per share, and the average cost of acquisition is Rs. 195 per share.

The following table shows these values for a period of 1 year (Like in real life, price movements of the ITC share are random).

Download the spreadsheet to create your own scenario

Thus, you can see that when the price is less, more shares are bought (26 shares when price is Rs. 195), and when the price is more, less shares are bought (22 shares when price is Rs. 223). Due to this, the average cost of acquisition gets reduced. That's how you benefit from market volatility if you can make disciplined investments every month!

And, since you don't keep looking for a low price to buy, and instead buy on a fixed date in a disciplined way, there is no question of timing!

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Note: Please treat the opinion expressed here as a broad suggestion. Please consult your financial planner / investment advisor before making any investment decision.