Index Funds : A positive perspective

When you visit a food court in a mall and you see different types of cuisine like Chinese, Italian, Mughlai etc. Your heart ponders how great would it be if you can buy a combo which has a fraction of the best of all the varied types. This wish is fulfilled when it comes to investing in an economy's stock market. The combo is called index funds which combine all the stock in the index and replicates its performance. An index is a composition of stocks with large market capitalization.

According to Warren Buffet, 'Consistently buy an S&P 500 low-cost Index fund. The trick is not to pick the right company, but the trick is to buy all the big companies consistently.' S&P 500 is an index that consists of top 500 companies in the USA.

So how great are these funds for the Indian market and why aren't these much popular?

Firstly, let's talk about the benefits of these funds in our portfolio. Since they just replicate the composition of an index so there is not much role of a fund manager and hence low cost. These are passive funds and so tax-efficient also as compared to other active funds present. They are ideal for long-term investing and also less volatile. A good pick for a risk-averse investor.

Then why don't we have much popularity for the same?

'The majority of funds outperform the equity benchmark on a consistent basis' says Mr. Nilesh Shah MD Kotak AMC. If we look at the statistics, then we can easily convey that active fund returns are better than that of an index fund in the market. India is an emerging country and has a great potential for identifying profit yielding funds and thus managers have a role to play.

This is a different scenario when it comes to USA market. There they have a broader and more indicative index comprising of 500 companies, unlike ours that has 30 or 50 top companies. Also paying for growth stocks doesn't make sense to most of the investors.

So should we just exclude the same completely from our portfolios?

As easy it is to compare and signify that active funds yield better returns than index funds, it's as difficult to identify those gold diggers. The volatility of the market keeps the scenario of stocks gullible even for most of the managers.
Also, No matter how better performing active funds are but there are always some risk and cost of management which is attached to it. On the contrary, the index funds provide you better hedge to risk and low cost of management.

For a completely naive investor, minimum SIP of Rs 500 allocated to this fund can be extremely fruitful in the long run. If we look at the graph below, which plots the returns of Sensex from 1998-2018 it shows how we could have gained multiple times from 1998-2018 if we would have just invested and forgot.

Let's look at some statistics, in June 1998 the Sensex was at 3026 points, whereas looking at the index this year in June, it was at 35028 points. The index has yielded almost 11.5 times over the year! This is certainly huge when compared to the counterparts like putting your money in bank fixed deposit.

Some of the top Index funds present in the market are UTI Nifty Index, SBI Nifty Index, ICICI Prudential Nifty Index, IDBI Nifty Index, HDFC Nifty Index.