Mutual Funds

Index funds: For simplicity in investing

Anil Ghelani | Updated on June 21, 2020 Published on June 21, 2020

Invest in a low-cost index fundto achieve your goals with a reasonable degree of certainty

Every Monday, we hold a meeting to review current macro trends, deep dive into sectors, look at business cycles, review company balance sheets, analyse management discussions from quarterly calls and keep an overall track of companies held across our portfolios.

There are many who have the expertise and passion to analyse companies, invest in the right companies and regularly monitor a portfolio of stocks. But then there are a whole lot of others who don’t have such expertise or the time and passion. How should they invest their money? It would be best to keep it simple and start by investing in low-cost, passively-managed index funds.

Warren Buffet, one of the best stock-pickers in the world, has made a similar suggestion for his wife who is not an investment expert. Keeping it simple for his wife, Buffet in his will has made an asset allocation for her with 90 per cent in index funds and 10 per cent in US government bonds.

In India, over the past few years we have seen an increased interest in index funds, and the trend is likely to continue. Index funds are slightly different from ETFs (exchange-traded funds) as they don’t require a demat account or a stock broking account. Hence, first-time investors who want to access the equity markets can easily start with index funds, either with a lump-sum investment or setting up a monthly SIP.

For a sophisticated institutional investor like a family office or an exempt PF trust, index funds could be used for taking a tactical view by investing in a transparent and low-cost index fund. Besides, the attractiveness for an individual investor could be to gain equity allocation by way of an easy-to-understand and well-diversified portfolio of the index fund.

 

As an individual investor, it would be prudent to follow a three-step approach, with inputs from your trusted financial advisor wherever required: i) identify and document specific financial goals such as new car, children’s education, retirementii) create an asset allocation and timeline for each goal iii) invest regularly with an aim to achieve your goals. For step three, financial advisors often suggest that the best approach for an investor looking to build a long-term portfolio would be to use index funds as a complementary strategy for gaining the requisite equity allocation by following a core and satellite approach.

For the core allocation in large-cap segment, use index funds which provide equity market participation at a low cost, without any fund manager bias. The core could be a combination of index funds on the Nifty 50 and the Nifty Next 50. This provides exposure to the large-cap universe comprising good companies, which are leaders in their sectors and have seen multiple business cycles.

So, your core allocation now has a diversified and transparent portfolio of such companies via just two low-cost index funds.

For the satellite allocation in the mid- and small-cap segments, use active funds, which provide the potential to generate outperformance over the benchmark.

The satellite could also include other investment classes for diversification such as gold, sector funds, international funds, etc, some of which might be for relatively shorter period of time.

So, your satellite allocation has a differentiated allocation, often needing a bit more analysis and research before investing.

The most important financial goals are usually common. For most of us, they are aligned to the happiness of the family, better life for children, starting or expanding a business/profession. Some of us often get preoccupied with the wrong priorities such as increasing returns at all costs or finding the next star fund manager.

A better approach could be keeping it simple by investing in a low-cost index fund, getting exposure to the broader market, with an aim to achieve your goals with a reasonable degree of certainty.

The writer is Head - Passive Funds, DSP Mutual Fund

Published on June 21, 2020
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