Benefits of Index Funds: After falling about 30 per cent since January 2020, the stock market has retraced some lost ground. The full impact of COVID-19 on the economy front is yet to be seen and may throw some more bad surprises. For a long-term investor in equity mutual funds, a considerable fall in NAVs is certainly a matter of concern. Many investors have seen the growth of several years getting wiped out in the recent meltdown. The damage has been more pronounced in managed mid-cap funds and even in the large-cap funds. On the other side are index funds which are emerging as a popular choice for investors. Is index fund the answer to investors woes?
Index funds perform in line with the index they track. After adjusting for tracking error and expenses of the fund, the index fund mirrors the returns that the index generates. So, if an index fund tracks the Sensex or Nifty 50, the returns over any period of time will be almost similar. The role of the fund manager in the selection of stocks, industries etc is non-existing.
The reason why index funds deserve more attention in the post-COVID era is the way our consumption-led demand pattern may see a change. There could be a new set of leaders in the market while some of the yesteryear’s leaders may see a fall in their valuation levels.
Some fund manager will be able to call the shots right while many of them could take a wrong call as well. Index funds are for those who do not wish to rely on the fund manager’s instincts and research rather ready to settle with market returns.
FE Online in an email interview with Nitin Shahi, Executive Director, Findoc Financial Services Group finds out the approach the retail investors need to take now, are index funds a better option for them and do they help investors in the long term.
Markets are showing increasing volatility. What should retail investors do now?
The advice for the retail investor in the present scenario is to invest strategically. The plan is to diversify the portfolio and using volatility for averaging the portfolio for the long term. The investor can invest Via ETF, Nifty Bees or invest in index funds which will result in diversification and can opt to invest a percentage of capital at each level. For example, an investor can opt to invest 20 per cent of capital at every fall of 5 per cent in the index. ( To some extent, this helps in avoiding to time the market )
Are index funds a better option to consider?
At this point of juncture, Index funds are better suited as an investment idea and are safer to invest, as it is difficult to understand and predict the full impact of lockdown on a particular sector.
Why are index funds considered less risky than other categories of mutual fund schemes?
Companies in the Index are considered most valued and considering the Index average return over the long term is more than 11-12 per cent which is not bad by any means. Index funds give you the advantage of diversification in the blue-chip stocks. Though index funds are subject to market volatility, they are the least risky funds at this point of time. The mantra for any investor to gain profits from the market investment is buying at the cheapest price. Investors who understand the dynamics of the market will invest now and benefit tremendously when the market recovers.
Are valuations of Indian companies lower now compared to what it was earlier?
PE of NIFTY50 is trading close to levels to 19-20 as compared to 28-29 in the month of January 2020. Due to Coronavirus spread stocks had taken a good hit. This is the reason I am suggesting to invest in Index Funds presently.
How do index funds solve the problem of which stocks to buy or which sector to invest in?
Index funds comprise of Index stocks in the ratio of their share in the value of the Index and the interference of a fund manager is minimum in case of index funds. So diversification problem is solved in this way and an investors will be investing in the economy on the whole.