Simplicity is synonymous with clarity, which is why it helps to keep things simple. “National Simplicity Day” is celebrated on July 12 every year to remind one and all of the need to enjoy simplicity in life. Complexities need not translate to success. Personal financial experts often complain about how they unwantedly get entangled in the complexities of daily investing, thus, underlining their willingness to focus on simple investment options too.
Go to any investment advisor about the simplest investment product in the stock market available, and you will hear all of them echo in favour of index fund investing. The famous saying, “The trouble with measurement is its seeming simplicity” aptly describes why many investors continue to disregard the idea to put their money in an index fund despite passive investments having earned more than active fund investments in the long run.
The simplicity of index fund investing may kill your passion for selecting stocks actively, comparing mutual fund performance on myriad parameters, or putting money in curated stock baskets (smallcase investments).
There are also times when investors spend hours evaluating market timings based on past details and then trying to time their investments. Nothing seems simple in stock market investing other than investing in index funds. For the unversed, index funds are mutual funds created to mirror the portfolio of the underlying indices while aiming to match their performance.
Before we move on to explain how the simplicity of index fund investments has helped many people earn great returns over a prolonged investment tenure, say a decade or two or more, let us see that Warren Buffett, one of the most iconic and successful investors of our time, acknowledged how individual stock picking may not be everyone’s cup of tea.
While explaining how a simple strategy that would be advantageous for long-term investors is investing in low-cost index funds, Buffett wrote in his 2016 Berkshire Hathaway annual shareholder letter, “My regular recommendation has been a low-cost S&P 500 index fund.”
Why invest in index funds?
Generally, an index is formed by incorporating the shares of leading companies in a particular economic domain or within a specific sector of the economy. This explains how index fund investors are already invested in stocks of some of the top companies without them having to go through the rigmarole of fundamental and technical details to decide on which stocks to pick, hold and sell.
Many newcomers in the market inquire about why to invest in index funds. Listing their benefits will underline why including an index fund is imperative in one’s investment portfolio, especially, for those who do not have the time to follow and catch market trends and then decide their investments accordingly.
Growth is certain
Index funds offer the potential for favourable returns over a long-term period, as evidenced by the impressive performance of key indexes such as the Nifty and the Sensex. The Sensex, with a base value of 100 in 1979, has generated returns 35 times its initial value over the past 39 years.
Similarly, the Nifty, established in 1995, has yielded returns 11 times its base value over the last 23 years. This indicates that investing in index funds would have still resulted in substantial returns over many years. It's worth noting that index funds can deliver moderate to strong returns over time due to their composition of stocks from leading companies, which are typically financially robust and have a solid track record.
Index funds eliminate the inherent bias associated with human discretion, which is a significant challenge in most diversified equity funds. Conventional funds heavily rely on the fund manager's subjective judgment, influenced by their conditioning, biases, and past experiences, thereby impacting the fund's investment strategy. However, in the case of an index fund, such biases are entirely eliminated. As a passive fund, an index fund aims to closely mirror the performance of the underlying index, disregarding any personal biases. While one might consider a fund manager as advantageous, the absence of human error in index funds ensures that your investments remain unbiased and free from potential faults.
Low expense ratio
Index funds offer significantly reduced costs compared to other investment options. This is because these funds generally feature lower expense ratios in comparison to actively managed mutual funds. This translates to a greater portion of your invested funds being allocated towards areas that can provide the most significant benefits to your portfolio.
Index funds offer the advantage of being easier to manage compared to actively managed mutual funds, as they tend to maintain a consistent asset allocation. Once you invest in an index fund, its asset allocation remains unchanged unless there is a deliberate adjustment made by the fund manager or a transition occurs to a new manager. This stability provides investors with a level of predictability and eliminates the need to closely monitor and adapt to frequent changes in the fund's asset allocation.
How many of us remember Jack Bogle – the founder of the famous investing group Vanguard Group who advocated the idea of exploring low-cost index funds, thereby, ringing in a change of how people invest? The father of low-cost investing was lauded by Warren Buffett for introducing this concept that helped many people to save and invest for their future.