What if I tell you that you can create wealth by doing nothing? Yes, it is true, you can create wealth by doing nothing. In this article, I will explain how to invest in an index fund that will create wealth for yourself without doing anything.
If you are a know-nothing investor, you should invest in an Index fund. By investing in an index fund, you are actually indirectly investing in the Indian economy. You do not need to search for the best or top-performing mutual funds.
The concept of investing in the index fund
There are two major indexes in the Indian stock market, Sensex and Nifty. Sensex was formed in 1979 with 100 points, today it is trending at around 37000. So the Sensex has given 350 times return in 39 years. So if you want to earn this much a return, you just have to invest in the index fund and that’s all, you are done.
Your money will grow with the growth of the Indian economy. Some mutual fund has performed some has not, but you don’t need to search best or top funds. Just invest in index funds and you are good to go. The index by design itself will keep the best performing company in the list and remove the non-performer.
What is Index Fund?
The index fund is nothing but the composition of the stock according to the index. It has the same weightage as the index has. If the index goes 2% up then your index fund also goes 2% up and vice versa. There is no need for a fund manager to manage an index fund, hence it is also known as a passive mutual fund.
Some Myth About Index Fund
If you are a first-time investor and have no knowledge of the stock market, you must go for index funds. As it is easy to understand and will give a good return in the long run.
Most of the people in India don’t have knowledge about index funds and they hunt for the best performing mutual funds all the time. The actively managed mutual funds can give higher returns but not always. There are many funds that have given good returns in 1-3-5 years but are vanished after that.
In India, understanding of index funds is very low. In the year 2000, for the first time index fund was introduced. There is another myth about index fund is that Index fund doesn’t work in the Indian context as there are many actively managed funds beating the index. But it is not true. In a long run, the index fund will give you a better returns as compared to actively return funds.
Another reason why Index funds are not so popular in India is there is a very low commission paid to the distributors so they are not promoting index funds. There is no need to manage index funds hence there is no fund manager so lower cost to the company.
The Evolution of Investment
Let me explain the evolution cycle of investment. When India got Independent, the problem with Indians were people were not saving money. The LIC of India came and their agents have explained the benefits of savings. They explained people to save money and invest them into LIC and they will get around 8% (FD-like) returns. But from the earnings, around 2% was eaten up by LIC agents. There is nothing wrong with it. If that agent had not come to you, you would have never start saving money and investing. So they have actually educated you on the concept of savings and investing.
Then after some time, the mutual fund company came into the picture. They have taught us that now we have learned the saving, why not invest it into mutual funds and earn higher returns than LIC. There is a fluctuation in the short period, but if you invest in equity for a long time, you will get higher returns as compared to fixed income assets like FD and LIC policies. They showed us the return as high as 15% as compared to 8% of LIC. They also charged 2% as commission, but still giving higher returns as compared to LIC and FD.
In the year 2013, SEBI has asked all mutual fund companies to launch direct plans of their mutual fund schemes. Direct mutual fund plans are the same as regular plans but investors are investing in the direct plans without any middle man i.e. distributors/advisors/brokers etc. These direct plans are giving higher returns of about 15% that too with less expense ratio. There are many online portals that offer direct mutual funds. This was a revolution in the mutual fund industry.
In the end, there are few people like me who have come and ask you to invest in an index fund and save even the small commission paid directly to the company. Invest into the index funds and don’t pay any commission to anyone still generate 15% returns and create wealth in the long run.
Invest in the Nifty index fund and you will save 1% on commission, this saved 1% commission will directly add up to your earned return. So you are actually earning whatever returns from the index fund + 1% (saved commission).
You might be thinking why are we making so much noise over that 1% commission paid to the fund manager for managing our money? To answer this question, I have already written an article on How to save money by investing in direct mutual funds? The 1% makes a huge difference in the long run. That will be actually the game-changer in the long run.
Some of you might also think that if they charge a 1% commission, they are giving higher returns than the index. Look at their past performance of the fund that paying 1% commission is not an issue.
Do you really think that you need a fund manager to manage your fund? if your answer is yes, read this article Any monkey can beat the market After reading this article, I am sure your take on the fund manager will change.
If at some point in time, your portfolio beat the market(index) is luck. Sustaining that performance year after year is a real challenge.
A know nothing investor that periodically investing in index fund, will be able to beat most of the investment professions
So if you are a long-term investor and start doing a SIP in an index fund then, in the long run, your return will be higher than most of mutual fund schemes. You will see and heard that mutual fund companies are claiming that they have beat the index and given a higher return. For example, one fund performance is 16% and index performance is 15% so they claim that they have beat the index. But in reality, there is a dividend of 1.5% which is over and above the index return. So real index return is 15% + 1.5% dividend = 16.5% So in this case mutual fund scheme has not beat the index.
There is a term called TRI (Total Return Index) that accounts for all dividends hence it is the total return generated by the fund. So actual comparison should be done against the TRI return and not just the regular return.
SEBI has regularised this in Feb 2018 by making it mandatory for the mutual fund companies to compare the fund’s performance against the TRI and not regular returns. This has changed the game and many funds that are earlier beating the index now are lagging behind as compared to the index.
Don’t try to find the best, buy the index and you will beat many best fund managers and advisors.
What is the role of the index fund manager?
Many people assume that the index fund is not an actively managed fund so the index fund manager’s job is very easy. Actually, that’s not true. The role of the index fund manager is to maintain the weightage of the fund to as close as it is in the index.
In the index fund, you cannot purchases fractional units so the fund manager needs to maintain the weightage the same as the index. There are people investing daily and there are people withdrawing daily. So it is very difficult for the fund manager to maintain the exact weightage as the index.
Why should you invest in Index Fund?
Investing in the index fund is easy and cheap as compared to actively managed funds. There are thousands of mutual fund schemes out there but only a few are able to beat the index in long run.
People are chasing the best mutual fund scheme every day. Those schemes are good for a few months or years but after that, the scheme is disappeared from the top list. There are lots of people who invest in the wrong mutual funds in search of the so-called best mutual funds. The cost of investing in the wrong fund is so high that the entire financial plan will go for a toss.
Another reason why you should invest in the index fund is if you invest in the wrong mutual fund scheme and after few years you switch to the new scheme or index fund, the cost of selling the existing one and buying the new one is huge. Sometimes, later on, you will realize that the cost of switching to the new fund is much higher so you will lose that much of your earnings.
What are the benefits of investing in index funds?
- You will get returns matching actively managed funds at a very lower cost
- You don’t have to worry about the star ratings and performance
- The index will keep on updating by itself based on the company’s performance so the best one will remain on the list
- You don’t have to worry about who is the fund manager
- You will always get the index return
- You don’t have to manage your portfolio on a regular basis
Disadvantages of investing in index funds
- If there is a fall in the index, your portfolio will also fall in the same manner
- You will not have downside protection in the index fund
How should I start index investing?
Investing in a mutual fund is for getting a good return in the long run. So you must have most of the asset allocation in large-cap companies. Most of the large-cap companies are a part of the index funds. You 60-70% of the asset allocation must be in these funds.
You can choose Nifty index funds as it consists of mainly large-cap companies. If you want to take a little bit of risk, then go for Nifty next 50 funds as it has some small and mid-cap companies.
Or you can choose Nifty 100 equal weight which is ebullient to the nifty 50 and nifty next 50 companies.
List of the best index funds in India
Once you have decided which type of fund is suitable for you, here is the list of the best index funds in India.
UTI Index fund
The UTI Index fund was launched in February 2000. It is a fund with high risk and has given 10.98% since inception. It is an open-ended fund with the objective to invest in companies of nifty 50 in the same proposition it has in the index.
This fund is performing good but in the recent past, it is giving lower returns as compared to NIfty 50.
As you can see from the above table, the fund has performed well in the long run. You can consider having this fund in your portfolio. in the 10 years performance, the fund has performed 1% lesser than the nifty’s performance.
The expense ratio of the fund is 0.13% as of 30th November 2018.
HDFC Index Fund – Nifty Plan
This fund was launched in July 2002. It has a high risk and given an 18.17% return since its inception. It is a 15 years old fund so the performance can be easily tracked. This fund has consistently outperformed its benchmark nifty 50 since inception.
The expense ratio is 0.30% as of 30th November 2018. The fund has given 14% in the last 10 years. The fund was launched in the year 2002 so its performance can easily be tracked
ICICI Prudential Nifty Next 50 Index Fund
The fund was launched in June 2010. It is a high-risk fund and has given a 12.65% return since its inception. The AUM of the fund is 157 Cr. Around 88% of the corpus is invested in large-cap companies and the rest is into mid-cap companies.
The expense ratio of the fund is 0.85% as of 30th November 2018. The performance of the fund over the various period is as below.