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Why Investing In The Index Funds May Be The Best Option For You?
If you are concerned about your finances and go online to find the best asset, you will hear the recommendations of investing in equities for the best chances of growth. But does everybody have the risk appetite and time to look after specific stocks? The answer by swooping margin would be a no. Therefore, in this article, we will discuss an alternate route to this and talk about investing in index funds, which can be more beneficial and suitable for you.
What exactly is Equity?
Equity investment involves buying shares from a platform for partial ownership in publicly traded companies such as Reliance, ITC, and Hindustan Unilever.
When you buy a share, you buy a part of the company, and when the business does well, the price of your shares shoots up, thus giving you a profit.
But think about it. Do you have the time and effort to read about individual companies and check how they perform?
Most likely, the answer is no. A general working class population can not handle separate time to look into such things. They prefer a simple instrument to invest their money and not think about it.
Thus comes the index funds.
What is an index fund?
Index funds are the collection of top publicly traded companies of any country. For example, you might hear about Nifty and Sensex in India, S&P 500, and Dow Jones in the US.
A separate governing body decides the list for the index. The companies get selected after a careful screening process.
One of the prominent factors for deciding the companies is their market valuation.
Market indexes often use the market capitalization of any firm to decide how much weight that security will have in the index. Market capitalization is a measure of the total value of the shares.
Nifty 50
Below is the distribution of the index fund named Nifty. There are 50 companies in this index with varied weightage. You can see the different sectors involved in this fund.
The Nifty 50 index includes companies from 14 different sectors to ensure that the index represents the overall performance of the Indian economy.
How is it beneficial to you as an investor?
The logic behind investing in the index fund is that it is a diverse fund. In the long run, some of these sectors, or more precisely, specific companies, will perform. Some will increase very slightly, and some might give negative returns, but when you take the investment as a whole, you will realize that the few winners will be sufficient to overcome the losses of others and still earn you a large sum of money.
A section from the book The Psychology of Money that might be a great addition here:
The Russell 3000 (another index in the US) has increased 78X from 1980. Forty percent of the companies in the index were effectively failures. But the 7% of the components that performed extremely well were more than enough to offset the losses.
The same has happened in the index of India. Some companies are the main driver behind the movement in index funds and are responsible for the growth. Many companies have been added and removed from the index, but it has consistently given a return between 11-13% annually.
If you scoff at these returns, you must understand that 85% of the fund managers, the professional people in this field, find it difficult to beat the index returns of 11-13%.
Below is an image including the calculation behind investing 50K monthly in an index fund.
Shocked by the fantastic returns? You can do even much more by investing for longer duration and by just being disciplined.
Some other benefits of investing in index funds are:
- Low fees: Expense ratios, or the annual charges made by mutual funds and exchange-traded funds, are often quite low for index funds. This is so that a group of analysts is not needed to choose specific equities for index funds, which are passively managed.
- Risk Management: Investing in a basket of equities rather than just one or two allows you to diversify your portfolio instantly thanks to index funds. If a certain stock underperforms, this can help lower your risk.
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- Tax effectiveness: Index funds generally outperform actively managed funds in terms of tax effectiveness. This is because index funds frequently buy and sell stocks less frequently due to their lower turnover rates. Fewer capital gains distributions, which may be taxable for investors, may arise from this.
- Simplicity: Investing in the stock market can be done simply and easily with index funds. You don’t need to spend a lot of time managing your portfolio or be an expert investor.
How to invest in an Index fund?
So, how to invest in the index fund? There are many platforms available for you to start your journey:
Some of them are:
- Groww
- Coin
- Paytm Money
There are many more platforms for you to choose from. But these are the most popular apps that work wonderfully.
Next up is choosing the fund:
Different companies are offering index funds:
Some are:
- Navi Nifty 50 Index Fund Direct-Growth
- UTI Nifty 50 Index Fund Direct-Growth
- Nippon India Index Fund S&P BSE Sensex Plan Direct-Growth
- HDFC Index S&P BSE Sensex Direct Plan-Growth
- Bandhan Nifty 50 Index Fund Direct Plan-Growth
The list is endless. You can check many more on any of the platforms.
How To Decide Which Fund to Invest in?
There are a few parameters to look at before deciding to invest in any of the funds.
- Expense Ratio: A fee payable to a fund house for managing your mutual fund investments. It is the percentage of fund assets used for administrative, management, advertising, and other expenses.
- Exit Load: A fee payable to a mutual fund house for exiting a fund (fully or partially) before the completion of a specified period from the date of investment.
There are other factors to consider if you choose any specific purpose mutual fund, but for the case of an index fund, you need not compare much data except these two.
The expense ratio for the Navi Index funds is one of the lowest in the market, thus giving you better returns. Expense ratio: 0.06%
Moreover, the exit load for this fund is Nil. So, if you intend to take out the money, you will not be penalized. I don’t think you would change your mind once you invest your money, but even if that were to happen, you can withdraw the money at zero cost.
How much to invest in an index fund?
Did you know there is a 15-15-15 rule stating that if you invest 15K every month for 15 years and grow your money by 15% you will end up with a corpus of 1 crore rupees? Isn’t it mind-boggling?
One of the habits you have to develop is regularly investing money. This is known as a Systematic Investment Plan. By using such a framework, you ensure that you remain invested in the market every time you receive your check.
As a general rule, it is a good habit to invest at least 50 percent of your post-tax earnings. It creates a good path for your future.
Go to the following link and fiddle around with the numbers.
Make sure to consider the time frame of at least 10 years. And the interest rate is around 11%. You can even lower the interest rate from 7-11% to understand how the money grows at each interest rate.
As you read about the 15-15-15 rule, you can experiment with 15K as the starting amount and adjust the amount according to the money you can invest and not think about it.
You may wonder, if all of the investments you are making are for a specific purpose, maybe for buying a house, maybe for your kid’s education, and many more events. But these prices are bound to increase in the future. Shouldn’t my investment be based on future expenses? And the answer is yes!
You should plan your investment according to that only and you can read about it in one of my other articles where I have made a detailed discussion on how to make an all-expense list and how to calculate the future cost.
Conclusion:
Index funds are a great way for salaried professionals to invest in the stock market. They are low-cost, diversified, and tax-efficient. If you are looking for a simple and easy way to invest for the long term, index funds are a good option to consider. It offers you peace of mind and allows you to invest your time in things that are important and not worry about fulfilling future needs.
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