Surprised?
I am asking you to invest, knowing very well that most of you may not be capable of beating the markets regularly.
Let’s be honest here. Most investors haven’t been able to beat markets consistently over long periods. I am not talking about greats like Buffett. I am talking about common people like You and me. People who have an intention of making a killing in markets, but somehow or the other, end being killed by the markets.
But if you know that you cannot beat the market, then does it make any sense to be in market?
Yes it does.
But first and foremost, please understand that accepting and embracing the fact that you are incapable of beating markets is an achievement in itself. 95 out 100 people in markets do not know this or don’t want to accept this. But it is the hard truth and tough to swallow.
But…if you are ready to accept this uncomfortable truth, then it can be one of your biggest strengths in stock markets.
Market has an unbelievable potential of creating wealth. On an average, markets deliver annual returns of 12% to 15% over long term.
For someone who is capable of beating these numbers, returns would be in excess of 15%. But for those who are not in markets, all they can possibly earn is 7% to 9% depending on taxes applicable on the chosen asset class like banks deposits, etc. By not investing in markets, these people are missing out on extra 3% to 5% which can be earned by staying in markets.
Now these might look like small single-digit numbers. But you will be shocked to see the effect these numbers have on your wealth over a period of 10-20 years.
And the graph below clearly shows this. It’s a very simple depiction of what happens when an annual investment of Rs 60,000 (5K Per month) grows at 12%-15% (Equities); and what happens when the same money is parked in safer options at 7%-9% (FDs, PFs, etc).
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| Returns on Rs 5000 per month investment in 20 years (At 7%, 9%, 12% and 15%) |
Over a period of 20 years, you would have put in Rs 12 Lacs, i.e. Rs 5000 every month. Now this can either grow into Rs 26 to 34 Lacs if invested at 7% to 9% class of assets. Or into a much bigger amount of Rs 48 to 71 Lacs if invested at 12%-15% in stock markets.
Now wait…if you think that markets guarantee 12%-15% every year, then that is not the case. Returns in market are volatile. It can be 50% in one year and (-)30% in another. But over long periods spanning decades, the average returns are in line with these numbers.
And this clearly means one thing…
Even if you cannot beat the market, you should still not avoid investing in it.
Avoiding markets would prevent you from achieving higher long-term returns when compared with other options like bank deposits, PF, etc.
So is there a way to invest in markets, which is…
1) Simple
2) Sensible
3) In line with the thought that it is not easy to beat markets?
The answer is yes.
And the way to do it is Index Funds.
What is an Index Fund?
According to Investopedia, Index Fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index (such as Sensex or Nifty 50). An index fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.
You might not know which individual stock or sector will outperform. But on an average, a carefully selected group of companies across sectors can do a decent job of maximizing diversification and minimizing exposure to few individual companies or sectors.
I am not saying that you should invest all your money in index funds. But if you think you want to save (invest) for long term, then atleast a part of your money should be parked in instruments linked to stock markets. And your safest bet can be Index funds. You can also choose well diversified large-cap or multi-cap funds which have proven track records. But that would mean that returns achieved by such funds would depend on fund manager’s ability to pick stocks. On the other hand, there is no active selection of stocks in index funds. Such funds simply replicate the composition of an index.
So if you feel that you have a knack of picking stocks which give market beating returns, then there is nothing like it and you should surely invest in stock markets directly.
But if not, then may be its time to think a little more seriously about Index Funds. And that is because if you are not in markets, then over long periods, you are missing out on some seriously big wealth creation opportunity.
Interesting Story:
When Google was about to launch it IPO in 2004, the company realized that this would create quite a few millionaires among its employees. The company therefore brought in a series of financial experts to teach them to make smart investment choices. A 1990 Economics Nobel Prize winner was also brought in. Even he advised Google employees “[not to] try to beat the markets” and to park their money in index funds.
Seems like Someone has rightly said – If you can’t beat them, join them. 🙂
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Good tips for investing. Really liked some of the tips.
Well said. Most people in India hate index funds but for a 20-25 yr timeframe with no knowledge of markets and no effort it's a fantastic way to preserve your wealth and increase it
Even Warren Buffett thinks that Index Funds are one of the best options for retail investors.
But Indian markets currently dont seem to be mature enough to give these funds their due respects. Almost everyone here is more interested in picking the top performing fund….and in that endeavor, switching funds every few months like they are individual stocks.
Thanks…
Index Funds are one of the best low cost options available for retail investors.
Here is No 1 Index MF in US call Vanguard Total Stock Mkt Index http://quotes.morningstar.com/fund/VTSMX/f?t=VTSMX Total Assets $347 Billion with B, best MF where you can close your eyes and invest. Indian mkt is not mature enough for Index funds IMO.
Right….Maturity of Indian Markets with regard to Index Funds is questionable.
Index Fund Vs NiftyBEES which are best option?
Also, best performing index fund vs best performing equity fund – is it comparable?
One can go in for either. Index Fund operates like a normal Mutual Fund whereas NiftyBEES is an ETF which is traded like any other stock on exchanges. In theory, both aim to provide similar returns which are in line with returns given by the index.
Again, the difference in performance of various index funds would be becasue of tracking errors and might not be very significant when compared with actual index returns.
Generally, the top performing fund (actively managed) would provide higher returns than an index fund in bull runs. But problem with top performing funds is that there is no guarantee that these will replicate great performances of past in future.
And no matter how thorough one is in analysing, one can never be 100% sure that the chosen 'top-performing' fund will do good in future. It is here that passive style of index funds helps in removing dependency on fund manager's talent.
Hi Dev,
I have been contemplating investing in index funds for the past few weeks.
One striking difference that I found between Nifty Index Funds vs. NiftyBEES ETF is the dividend given to unit holders. NiftyBEES ETF is the only Index fund that I have found that pays dividends (~0.9% dividend yield) whereas other Nifty Index Funds do not pay any dividends. Considering a Nifty dividend yield of 1.3%, I wonder where the dividends received by these fund go. Are they used to service their higher expense ratios?
Another thought, Shouldn't such Index funds (that do not pay dividends) be bench-marked against the Nifty TRI instead of the Nifty?
Cheers,
A fellow Stable Investor
Dear Dev,
I am taking my investments seriously after going through your articles. Thanks a lot for enlightening folks like me on various subjects.
I am planning to invest in an index or ETF fund long-term. But little worried as mentioned by some experts that Indian markets are not mature enough.
Please advice if I should go ahead and invest. If so, please advice on the top index funds.
Thanks,
Hi Tridip
Though its wrong to write-off index funds/ETFs, the fact is that there are many actively managed funds which have beaten the index handsomely over the years. And that too at a slightly higher expense ratio. So when a fund is able to beat index by 5%-8% consistently, then paying up a little more, for active fund management makes sense.
I hope it answers your question.