Make investing simpler with index funds

Investing in equities is always an attraction amongst retail investors for its wealth-creation potential over the long term. However, as interesting and exciting it may seem, the art of
investing is indeed tricky.

The S&P BSE Sensex has given 16%+ returns on an annualised basis over the past 42 years since its inception in 1978. In the lifetime of the index, there have been numerous companies listed on the stock exchanges with varied performances and while some companies have grown multi-fold over the years, many others have vanished after giving promising listing gains.

In general, investors tend to understand broader market indices better, as they are widely followed and quoted compared to individual stocks.

Investors are more likely to know the performance of a S&P BSE Sensex or NSE Nifty50 Index rather than how an individual stock or fund may have performed.

With individual stocks and mutual fund investments, one needs to regularly review the portfolio and performance to ensure that the investments are performing in-line with objectives.

This is where index funds / ETFs come into the picture. Index funds / ETFs are such funds, which track an underlying index and invest at least 95% of its net assets in replicating that index. They offer passive investment opportunities to investors, wherein they can expect similar returns as that of the underlying index.

There might be some variation in returns due to fund expenses and tracking error, which may arise due to rebalancing, holding excessive cash or differences in weights of the portfolios compared to the underlying index.

When one makes investments into stocks or mutual funds, one is likely to come across systematic risks and unsystematic risks. While systematic risks are the risks arising from macroeconomic conditions and investing sentiments, unsystematic risks reflect the risk of making wrong investment choices.

With index funds not providing any flexibility to the fund managers to think and act beyond the underlying index’s composition, such funds eliminate unsystematic risks for investors.

Additionally, the benchmark indices are continuously evolving with changes regularly made depending on data-backed analysis; the investors effectively delegate the task of portfolio monitoring to the broader market participants instead of relying on the fund manager’s investment conviction.

As passive schemes track an underlying index, it does not involve any active stock picking resulting in lower fund management charges.

This effectively translates to relatively lower expense ratios for investors as compared to actively managed schemes which in effect means more of your money is working for you. Thus, index funds/ ETFs not only make your investment journey simpler but also more cost-effective.

With the continual evolution of financial markets, market indices are swiftly aligned with the market dynamics, and the fund managers may find it difficult to generate alpha which is already evident.

This is the reason why passive investing tends to dominate the industry AUM in the developed markets.

With the current penetration levels of mutual funds in India continuing to be significantly lower than the global averages, it is likely that the next growth cycle for the mutual fund industry will be driven by passive investing options. Be a part of that evolution and make your investing simpler and achieve your investment objectives with passive funds.

(The writer is Head – ETF, Nippon Life India Asset Management Limited)