The classic expression “If only I knew then what I know now” used to repent for learning many things and matters late in life. Of course, experience is the best teacher, but it comes at a cost. It comes with age and after going through a lot of hits and misses. Learning never stops but then some things are better when experienced early.
Take, for example, an understanding of personal finance that most people gain later in life only to regret not having learned it much earlier. The proclivity to park money in fixed deposits slowly shifts to investing in mutual funds, stocks and shares. Many millennials prefer to allocate their money to risk-bearing equity funds that will help them create a corpus in the long run.
However, in the beginning, it may be difficult for many people to decide on the right investment vehicle, especially, in equities. Index investing serves them best considering how these passive funds mirror the market movements and earn you returns in sync with the market.
Index investing seems boring to many, and hence, largely ignored. This is because the young generation finds it exciting to screen stocks using online tools, study companies’ earnings from their balance sheets and gauge their potential depending on the demand for their products and services to decide whether the stock is worth their consideration. Then, comes the complex task of deciding the stock’s valuation to avoid buying overpriced shares.
Considering how this process is time-consuming and involves a lot of research and advice from financial experts, some seek help from social media influencers to decide on their stock investments and allocation. A good choice of stock(s) helps them strike gold when bought and sold at the right time, else it may result in losses too. Irrespective of whether they gain or lose, they continue to indulge and invest in stocks for that constant adrenaline rush that they deem exciting.
Benefit from passive management
Index funds, in comparison, are passively managed funds that replicate a particular market index, say the Nifty50 Index or the S&P Sensex 30. The replication is in its entirety as the index funds not only pool investors’ money to put into companies listed on that index but also invest according to their weightage in the index. This means that an index fund will buy and sell all the securities listed on the index in the same proportion as the underlying index. Rebalancing of stocks in the index will automatically result in similar changes in the index fund too.
The passivity in index fund investing translates to complete non-interference by the fund manager(s), thus, eliminating the risk of biasness or tendency to succumb to market rumours while managing funds. Since these funds use passive investment strategies, many of them have a very low expense ratio. This means that you spend less on each investment to avail the benefits of putting your money in them.
Take, for example, one of the Nifty50 Index Funds is the Nippon India Index Fund S&P BSE Sensex Plan which has earned 222.30 per cent absolute returns since its inception and charges an expense ratio as low as 0.15 per cent. Money invested through systematic investment plans (SIPs) over the past five years has yielded more than 16 per cent returns in the past five years.
HDFC Index Fund - S&P BSE Sensex Plan is another example of an index fund that has earned 234.90 per cent absolute returns since its inception. The fund yield over five years is 14.67 per cent, which is way more than what one earns on stock picking, investment and holding it for a period. Also, the expense ratio is 0.2 per cent, which is negligible compared to most other actively managed mutual funds that yield similar returns, albeit at higher costs.
You can go through a host of index funds launched by many asset management companies to learn about their performance and how investing in them will not help you earn returns that beat inflation but create a corpus for you to rely on.
Portfolio diversification helps
Investing in only one variety of stocks or funds will make you vulnerable to immense volatility. This is why you must opt for portfolio diversification that involves parking money in different kinds of investments. This means that even if one kind of investment suffers, you still stand to gain from movement in the remaining investment options. Index investing also exposes you to different kinds of stocks with different market capitalizations and market positions, thus, allowing you the much-needed portfolio diversification within the same underlying index.
The similarity of investment options
Like most other mutual funds, you can choose to invest either in a lump sum or through SIPs at regular frequencies, be it weekly, monthly, quarterly, half-yearly or yearly. This makes it equally easy to invest in these funds as you can either automate your index fund investments or park money depending on your financial goals.
Are all index funds the same?
Just like myriad equity funds that differ in market capitalization and allocation into various kinds of investments including equities and debt funds, index funds offered on varying indices differ depending on whether the money would be put into large-cap, mid-cap and small-cap funds. Some are more exclusive in the sense that they invest in a particular theme like health, information technology, banking sector, etc. Still, there are others that mimic the allocation and movement of NASDAQ 100, thus, lending them the much-desired international exposure.
Choosing to invest in index funds is most underrated, especially, by young investors. What most do not realize is that it is the easiest way to take exposure to equity markets without going through the hassle of putting money in various stocks or constantly balancing your investments between equities and debt funds. An index fund must be the first step in deciding your investment portfolio considering the benefits of its overall asset allocation.
