scorecardresearchShould new investors park their earnings in passive index funds to create wealth?

Should new investors park their earnings in passive index funds to create wealth?

Updated: 13 Jul 2022, 10:41 AM IST
TL;DR.
Creating a passive portfolio is not difficult if you know which market cap you are inclined to bet your money on. Index funds are a great investment option, especially, for those with a long-term vision and who wish to get rid of the stress of active fund investing. 
Investing in index funds can be a great way to create wealth

Investing in index funds can be a great way to create wealth

The markets are down. Investors are feeling afraid. The prolonged bearish run has outrun most investors’ patience and risk-taking abilities. This is evident from statistics pointing out how new registrations for fund investments through systematic investment plans (SIPs) have come down considerably in June this year when contrasted with the May data this year or the June data last year.            

While active investing is still in place, the fear of putting money in active funds remains. This explains why many more investors are cosying up to passively trading index funds and exchange-traded funds (ETFs). If you are not adept at the stock market nuances, you may as well put your money into investments that are in sync with the market and would not need your constant assessment and monitoring.

To build a passive portfolio, you must be willing to park your money in index funds and ETFs only though many people prefer investing in the former due to lack of liquidity, thus, forcing many investors to sell units at a lower price when they want to redeem their investments.

Passive investing is not difficult. You must first be aware of the market cap in which you invest. For example, those resisting extreme volatility can opt for the Nifty 50 index or the S&P BSE Sensex funds. The Nifty Midcap 150 index fund serves best to those willing to put a part of their earnings in mid-cap funds that invest in mid-cap companies with increased scope for both risk and returns. Index funds made up of Nifty Next 50 offer both value and momentum as newly listed companies rely on technology to yield returns.

Investing in only one index fund is enough though you may invest in multiple passive funds to build a low-cost portfolio and earn from it at various stages of your life. 

Large-cap index funds

Start with index funds listing large-cap companies. Investing in these kinds of funds allows you exposure to large-cap companies. You may choose to park your money in either Nifty50 or Sensex-based funds or both. If stability bores you out of your wits, put a small amount of money regularly in the Nifty Next50 index fund to get a taste of the kind of restlessness that the stock markets offer. 

Mid-cap index funds 

Risk is synonymous with returns in the stock markets. Investing in index funds listing mid-cap companies is equivalent to putting money in mid-cap stocks where there is relatively more volatility than the large-cap varieties but are relatively more stable than small-cap stocks that swing violently on both sides in response to market movements or news affecting stock movements. You have both the Nifty Midcap 150 and the Nifty Midcap 50 funds, the former allowing you to invest in more companies, thus, diversifying your risk while the latter spreading your risk among 50 odd companies alone. Based on the factor index, you may also put money into the Nifty Midcap 150 Quality 150 index fund. Investors continue to invest in factor index funds though the concept is comparatively new in India.

One may argue that actively managed midcap funds yield better returns than midcap index funds in the long run. However, the former still requires you to regularly check on how your funds are performing and if you must switch to another fund that may be more actively managed. Index fund investing being purely passive in nature leaves you free to work on other investment options and interests as the returns are in sync with how the overall market is behaving, thus, leaving no scope for modification or change.  

Small-cap funds 

Not many are inclined to invest in small-cap funds owing to their immense volatility and sharp fall in returns when the markets go kaput. However, if you are a long-term investor willing to invest more than two decades in this kind of fund, returns are bound to follow. However, if you are not in favour of feeling stressed out under the impact of volatility, you may avoid investing in small-cap index funds. 

Seeking international exposure

Putting some money in US funds can serve as a way to hedge your investments. Once you are done investing in Indian equities, you may consider inching towards international markets too via their index funds. Many investors opt for the US-based S&P500 index fund to experience exposure to developed markets in the US. Those with a higher risk appetite can put their money in NASDAQ-based US funds. 

Exchange-traded funds (ETFs)

Some people choose ETFs over mutual funds owing to their low expense ratios. But is contrasting expense ratios data enough? You must look at the volume of transactions and extent of liquidity before putting money in ETFs. Index funds score better in this regard, sans the hassle of trying to sell or redeem units at market value as and when needed. 

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First Published: 13 Jul 2022, 10:41 AM IST