“I made the smartest investment decision of my life yesterday,” a friend told me over phone.
“Did you finally stop trading in share market?” I asked him jokingly.
“Shut up! What I did was to invest in a good index fund,” he said.
“And why did you do that?” I asked.
“You see, the index fund will keep my money safe as the returns won’t depend on the whims and fancies of the fund manager while my money will grow in line with the stock market,” he replied. “I believe every investor must have an index fund in his portfolio.”
Well, this wasn’t the first time I heard someone ‘sell’ me the idea of an index fund and why it’s a must-have in a small investor’s portfolio.
But I have never invested in index funds in the past, and don’t plan to do that in the future as well.
By the way, for the uninitiated, an index fund is a type of mutual fund scheme that invests in a basket of predefined stocks of an index (like the BSE-Sensex or NSE-Nifty) in an allocation that resembles that of the benchmark index.
So an index fund is like a passively managed fund, where the fund manager just has to buy and hold the stocks that form part of the index, and exactly in the same proportion.
In other words, if Infosys has 10% weightage in the Sensex, an index fund tracking the Sensex will also hold Infosys as 10% of its portfolio.
Anyways, there are several reasons I don’t like to invest in index funds. Here are three big ones…
1. Index funds buy high, sell low
Index funds largely track the market capitalization of companies that form part of the index.
So as a company gains in market capitalization (and thus gets expensive in terms of valuations like price-to-earnings or price-to-book value), the index fund manager has to buy more of it to get it to a higher weightage in his fund as well.
On the other hand, a company that falls in market capitalization and also in terms of valuations gets a lower weightage in the index. The index fund manager follows by selling a part of this company from his fund to match its new weightage.
An index fund is therefore an automatic mechanism to buy high and sell low. I don’t recall this tactic ever being given as a sane investment advice.
2. Index funds buy the past, ignore the future
Index funds tend to have the most significant portion of their assets in large, mature companies.
While this may sound a ‘safe’ strategy on the face of it, the problem with this it that the largest companies in a stock market index are yesterday’s winners.
They got to be the largest by delivering exceptional returns to investors over the course of many years, but in the past.
However, given the way industries develop, grow, mature and then decline, it is likely that most of these companies will earn much lower returns in the future. This is however barring a major reinvention led by a strong management team, which we anyways find in very few companies in India.
So an index fund is largely a portfolio of mature companies, many past their prime and with years of stagnation or decline ahead of them.
While I personally give a lot of preference to the past performance of companies, I am more interested in where these companies are headed in the future (not in terms of EPS numbers, but in terms of their businesses).
So a company that has a great future ahead of it in terms of business potential is what attracts me. And index funds don’t tend to hold such companies.
3. Index funds stick with stocks till they’re kicked out
The ranking of the 30 largest companies in India changes nearly every second as stock prices fluctuate up and down.
This isn’t a big deal for companies that are at the top of the rankings. However, at the bottom of the table, some companies drop out of the list while other companies manage to sneak into the top 30.
As a result, the BSE periodically drops some companies from the Sensex (that aren’t doing well in the stock market) and adds others (that are doing well).
What do you think happens before and immediately after the BSE makes these changes to the index (the Sensex)?
Since index fund managers have to follow the indices’ portfolio weights in order to minimize their tracking error, they hold on to the dropped companies till the last second while active managers sell them weeks or months before they’re dropped from the index (and for other reasons that are related to business performance instead of stock market performance).
Index fund managers also don’t start buying the newly added companies until they’re officially added while active managers already have the new (and better) stocks in hand.
Let me prove this with some examples. Here are six companies that have been excluded from the Sensex over the past 3 years. The red marks shows the day on which these were excluded.
Just notice the way these stocks performed during the one year prior to their exclusion.
I’m not sure if a good active fund manager would’ve held on to these stocks for so long (till they were finally excluded from the index).
This is especially true for companies like Mahindra Satyam, Reliance Communications, and Reliance Infrastructure that were deteriorating businesses for more than a year before they were excluded from the Sensex.
Data Source: BSE, Ace Equity
So why should I invest in an Index Fund?
Warren Buffett and Benjamin Graham have recommended index funds as one of the best investments for small investors who don’t have the capacity to pick their own quality stocks or mutual funds.
This is exactly what peddlers of index funds have been using as their rationale to sell such funds in India for long.
However the thing is that it may make sense for American investors to invest in index funds simply because the index funds there are far more indicative of the broader market (as they track indices that contain 500 to 5,000 companies).
In India, you have just two indices available – the 30 share BSE-Sensex and the 50 share NSE-Nifty. Such a small number of companies are anyways not indicative of the broader Indian market.
What is more, as I’ve explained above, the way the Sensex (or the Nifty) are constructed makes them just a shabby collection of big companies/expensive stocks.
So if a great company isn’t big or if a large percentage of its shareholding is held by promoters (which means a low free-float), it will never find itself in an index fund (while a smart fund manager would own it in his actively managed fund).
Alternatively, just because it is a big company and has seen a great rise in its stock price in the ‘past’, it will sneak into the index, and thus the index fund.
You don’t buy stocks like that, right? So why buy index funds that buy stocks like that?
As for my personal investments, I would any day prefer my own research and the stock picking skills of someone like Prashant Jain or K N Siva Subramaniam or Sukumar Rajah to grow my small wealth over the long term.
I find sailing in a leaky boat in a ‘supposedly’ calm river (index funds) much more dangerous than sailing in a non-leaky boat in high seas (carefully managed active funds…and there’re just very few of them).
What about you? Do you invest in index funds? If not, what’s your view on index funds? Let me know in the Comments section below.
Hi,
While i agree totally with the first reason, you seem to have ignored the fact that there are multiple index that exist around small caps, mid caps, sectoral, etc… A index fund is not just about the Sensex or Nifty.
Secondly, on buying the index funds, a systematic investment would always take care of the volatility bit.
Thirdly, not all fund managers are able to outpeform the market, hence a fund which does away with that manager risk, may not be a bad idea at all.
Finally, i agree that the index construction is flawed. But if there is a good index, wouldn;t it still make sense to invest in one.
Thanks for your comment Vipin! The funds that you are talking about (sectoral, midcaps, smallcaps. etc.) are more of ‘thematic’ or ‘benchmark-based’ funds than index funds. As I’ve explained in the post, when I say ‘index funds’, I mean funds that exactly track their respective indices. So in India, we just have index funds that track the Sensex or the Nifty.
On your second point, an SIP in ‘expensive’ stocks won’t save you from any volatility.
On the third point, yes you are right. About 80% of equity schemes in India have underperformed the Sensex over the past 5 years. But then, as I mentioned, investors still have good funds to choose from the remaining 20%. And while you may do away from the ‘fund manager’ risk in index funds, you are taking an equal big risk of going by BSE’s or NSE’s calculations of creating the indices.
On the fourth point, yes it would make sense to invest in an index fund if you can find a good index. But then, as I mentioned in the post, a ‘good’ index is what we are missing in India.
The U.S. Index (S&P500) has a few advantages:
1. Multi decade long history for us to judge
2. Reliable Records
3. High caliber picking of stocks to add to index or delete from the index
4. The U.S. Legal system in case some manager of the index cheats investors ( 150 year prison sentence for Madoff is prime example)
5. The U.S. system of allowing those talented to rise NOT those with political influence
I would buy the USA Index now & wait another 50-100 years to see how the Sensex based index does.
I am a patriotic Indian but this is money ( thus different)
HI Vishal ,
Great post and mostly i agree with your views. Just a few thoughts from my side.
Its easy for professional investors to say that Index funds are not he best tool to mazimixe returns but for retail investors, i strongly feel that its one of the best ways to invest. Retail investors can choose from following choices:
1) Dont invest
2) Invest on their own and loose money
3) Invest with some stupid MF scheme and hope they do well
4) Or invest in Index Funds
Though the first two options are not to be considered but out of the last 2.. lot of retail investors have bitter experiences of MF fund managers. Infact you must be knowing how they operate.. running from one qtr to another for performance.. buying stocks to show better NAV. But i do agree that investing with Prashant Jain is one of the best options.
The last option to do is replicate index and let it move on its own. Infact , as you have described in your personal profile that from 1978 till now Sensex has gone up 200 times. So had someone bought an index fund around the same times, his returns would have been 200 times.. Simply superb. During these lot of stocks have been included and excluded from index, but nothing seriously went wrong with Sensex. In mid 90s, Sensex was full of family run businesses like Century Textiles and all.. yet Sensex has managed to deliver 18% CAGR for 32 years.. wat else an investor wants. i am sure professional investors has made far more money.. but this is your job.. day in and day out they do this only.. but for retail investors this is not what they are great at.
Its better if they invest in Index funds and wait for next 10 – 20 years to get amazing returns.
Thanks for your detailed feedback, Amit! I’ve covered some of my view-points in the response to Vipin’s comments above.
Especially about your 2nd and 3rd point, I totally agree that investors have lost a lot of money in the past investing in bad stocks and mutual funds. But that is what Safal Niveshak is trying to change – not just in terms of how people must pick good stocks and mutual funds, but also in terms of how they must conduct themselves while investing their hard-earned money.
So if one knows how to identify good stocks and mutual funds, and have the right discipline, he/she can do well than 99% of fund managers out there.
Yes, you are also right in pointing out that the Sensex has multiplied money 200 times in 32 years. But then we are talking of a very low base. Also by assuming that such a performance would repeat over the next 20-30 years can be dangerous. After all, we humans tend to look for patterns when none exist! What is more, we don’t know the 33 year performance of any investor who was intelligent to invest on his own or had found a stock picker like Prashant Jain back then. It might’ve been even better than 200 times. 🙂
Overall, I believe that a small investor has a greater chance to outperform a professional like me over the long term by just sticking to the basics of investing and human behaviour and staying put with good quality stocks and mutual funds. With index funds, you just shift the responsibility of your wealth creation to passive fund managers who themselves go entirely by what the men in BSE or NSE do.
Pls note S&P 500 is a much broader index. Covers more than 80% of the market cap, right?
SIP is expensive could be true for any fund for that matter and not just index fund.
Also, doing it on your own is still an effort. So, what do i do if i don’t have the time. i need to trust a professional manager and his intelligence based on certain parameters or an index fund?
Yes Vipin, but we don’t have a S&P 500 in India! Also if you take the BSE-500 Index, we don’t have indices tacking it.
I’ll correct myself – I meant to say “SIP in expensive stocks” and not “SIP is expensive”. Have corrected that in my previous comment.
In case you don’t have time, it’s good to invest in a carefully-selected active fund managed by a trustworthy fund manager (and we have a few such funds in India).
Hello. Can you please let me know where I can have access to the full list of indian firms and their Z scores?.
Hi Ganu, I am not aware of any such list. Z score is something that you can calculate on your own using the formula I suggested in this post – https://www.safalniveshak.com/alt-ctrl-del-these-stocks-from-your-portfolio/
‘In case you don’t have time, it’s good to invest in a carefully-selected active fund managed by a trustworthy fund manager (and we have a few such funds in India).’
Can you share such fund mangers? Thank you!
if assuming sensex to perform next 20 to 30 years is dangerous same can be the case with assuming a fund manager to deliver the same in next 20 years because market has tamed best of the fund managers,peoples memory is very short many of the so called star fund managers of 90″s have faded away into oblivion.For a layman and new investors Index Is the best way to invest at least he is investing in the market and not on a individual who can leave the fund any time.
Hi Srinivas, please do not get me wrong here. What I mean to say is that while the Sensex may/may not perform equally well in the future as it has done in the past, given the way an Index Fund is constructed and the sanctity of the benchmark indices in India, I would be more comfortable investing with a sensible fund manager (he may or may not be a ‘star’ fund manager) in an active fund.
And by the way, like I take the risk of a good fund manager leaving the fund (in that case I’ll reconsider my options anyways), I also take the risk of seeing some great businesses exit the Index and get replaced by dud businesses (some of which I talked in the above post) during a bull market.
Of course, this risk is backed by my belief that if the Sensex can give me 15% annual returns over the next 15 years, I am investing with a fund manager who has handsomely beaten Sensex for the past 15 years and has the ability to do so in the future as well (so I am seeking patterns where none might exist, and that’s the risk I’m willing to take :-)).
One more thing, I would like to say that not having Index Funds in my portfolio (for the reasons I mentioned above) is my ‘personal’ investment strategy which I wanted to share with my readers. I have not said that no one must have Index Funds in their portfolios.
The choice is very individual and is dependent on the kind of risks one can take and the investment horizon. So it’s purely an investor’s personal call whether he must/must not have Index Funds in his portfolio. I just laid down the reasons why he must not. 🙂
Prashant Jain’s performance in HDFC Prudence would suggest that your faith in this gentleman is overrated. Index fund has outperformed Jain’s funds by miles. I would any day trust the index rather than a so-called celebrity fund manager.
I will have to start rethinking on my ongoing SIP investments in indices…..Your article has helped me look beyond the obvious…..it has altogther chaged my ptespective on sensex stocks…..I will have to restratigize for sure !!!! Thanks for such a good analytical, logically, factual and an correct eye opener article….!!
Hi Sam, thanks for your feedback! But before you rethink your decision with respect to your index fund investments, have a look at today’s post – https://www.safalniveshak.com/5-steps-to-create-personal-investment-strategy/.
This might lead you to change your mind and stay with what you already have. 🙂
Dear Vishal
There is fund called Goldman Sachs S&P CNX 500 Index Fund (G) which tracks about 96% of total market capitalization and about 93% of the total turnover on the National Stock Exchange of India (NSE)
Is it not a good beginning and a good fund?
Yes Dr. Khan., I rechecked with a couple of financial advisors (who had denied earlier that such a fund exists :-)) and they’ve mentioned that this index fund that tracks the S&P CNX-500 Index does exist! However, the view is that at 1.5%, the expense ratio of this fund is on the higher side (given that the average expense ratio for Index Funds is around 1%). Also, what I’ve been told is that the performance has been pretty volatile in the past even as compared to most other funds that are indexed to the Sensex or Nifty – largely due to prevalence of several mid and small cap stocks.
So, yes, you can do more research on this fund (or get an advice from your financial advisor) whether it is worth investing into (especially given the high expense ratio).
Nice article again. Although, I do not have any index fund only for one simple reason that there are few fund managers in India who has been consistent in terms of beating the index. That is enough reason for me to stay away. Your reasons for not investing is insightful. Like other commenter are discussing about an average investor do not have time, I don’t believe that it is so difficult to hand pick few funds and keep doing SIP, it’s a one time process and reviewing once a while. If one does not have time for this too, it’s difficult.
Thanks for your comment, Mansoor! Just one correction though.
You wrote, “Although, I do not have any index fund only for one simple reason that there are few fund managers in India who has been consistent in terms of beating the index. That is enough reason for me to stay away.”
Well, index funds are designed to ‘not’ outperform the index. I would be worried if I see an index fund manager outperforming. 🙂
Yes yes I agree, it didn’t come out the way I wanted. What I meant was that other funds are “better” than index fund. Index fund outperforming the index, lol, that would be funny.
Dear Mr Vishal
I know that the expense ratio for the Goldman Sachs S&P CNX 500 fund is 1.5%. But, does an extra 0.5 % a reason to not consider this fund?( The fact that it is run by Goldman Sachs may be cause for concern, though!).
But, it is a fund which meets the benefits that an American investor has, like you yourself wrote…”However the thing is that it may make sense for American investors to invest in index funds simply because the index funds there are far more indicative of the broader market (as they track indices that contain 500 to 5,000 companies).”.
Does this fund not do the same for an Indian investor?
Yes Dr. Khan, this fund does a similar thing for Indian investors as the more diversified index funds in the US do. So you can have a small portion of your investments in it. But just check out the credentials (past performance etc.) before you make a move.
The article is wrong in that Ben Graham did not recommend Index Funds as he lived before Index Funds. Warren Buffett did pick Vanguard S&P 500 Index funds for his will with only 10 percent in US Treasuries
Hi Vishal,
Your article exposed some of the valid facts why Index Funds is not the best choice from Indian Investor perspective. It is quite rightly not so popular among Indian investors.
Most financial advisor do not recommend to invest in it. It is not for the reason that it is not good for you. But, it is just because they do not earn good commission from it. Tommorrow, let the AMCs declare more commissions in it, most Advisors will start recommending it.
I never invested in Index Funds. In the last 7 Years, whenever, I made an attempt to invest in invest funds, my regular check on long term return difference between an Index Fund and Actively Managed Fund (quality funds managed by a reputed fund houses) never allows me to invest in an index fund. The difference is quite huge especially in a very long term. Such difference can make a huge impact in reaching your Goals. As a fact, let us compare the returns of Index Funds and Actively Managed Funds:
10Years Return for :
Franklin India Index NSE Nifty 18.15% P.A
Franklin India Index BSE 17.59% P.A
Franklin India Bluechip 25.23% P.A
Franlin India Prima Plus 25.22% P.A
7 Years Return for :
Franklin India Index NSE Nifty 12.30% P.A
Franklin India Index BSE 12.42% P.A
Franklin India Bluechip 16.52% P.A
Franlin India Prima Plus 16.49% P.A
5Years Return for :
Franklin India Index NSE Nifty 1.90% P.A
Franklin India Index BSE 1.73% P.A
Franklin India Bluechip 6.19% P.A
Franlin India Prima Plus 5.66% P.A
3Years Return for :
Franklin India Index NSE Nifty 4.03% P.A
Franklin India Index BSE 3.44% P.A
Franklin India Bluechip 9.24% P.A
Franlin India Prima Plus 9.70% P.A
1Years Return for :
Franklin India Index NSE Nifty -8.84% P.A
Franklin India Index BSE -9.50% P.A
Franklin India Bluechip -4.17% P.A
Franlin India Prima Plus – 3.51% P.A
It is very evident from the above facts that Active funds outperform Index funds by a wide margin. I have taken just two quality funds for comparison. There are other quality funds that have consistently outperfomed even the two active funds that I have chosen in the above comparison. The fact of quality active funds outperforming the index funds cannot be denied and neglected.
The question is which fund to choose? By educating yourself, you can easily choose quality funds easily. Only ignorant investors can say it is tough to choose such funds.
The other question is the so call Star Fund Manager. I do agree there is a certain level of dependence on the Fund Manager. It is like getting a surgery done through a Robot or through an experienced Doctor. If you will depend on a star doctor for your surgery and followup treatments, the same does apply to Fund Manager.
There are quite a few fund house that follow good investment process and it if for us a investor choose such fund house and funds to invest in.
I do agree there is a certain element of risk in investing through active funds however the benefits in an active funds much more in comparison to those risk.
Another point is about lower expenses of Index Funds. It is worth paying the active funds to outperform the index by such a wide margin. After all the returns shown above are after accommodating the expenses.
Hence, I would always choose a Active fund.
Thanks Ajay for your invaluable inputs as always! You’ve made this discussion highly enriching. And yes, I second your thoughts on picking up good active funds over index funds. Regards.
Hi Vishal,
1. Index funds buy high, sell low – Testing this with an example.. If all the holders bought last year and they are not buying anymore the fund will not purchase anything and if the fund represented Jan 2011 index it will be same in Jan 2012 except if new stocks go to the index right ? Am i missing something ? In other words tracking error will not create significant Buy high and Sell low… I agree Kicking the funds is different and you explained that in point number 3.
2. Agreed.
3. Agreed. Remove Satyam from your graph as Raju fooled everybody including the best fund managers like Prashant Jain 🙂
Thanks
Jai
Vishal,
Great post! I found your three arguments intriguing (Although on the first glance, your 2nd point makes you seem more like a growth-investor rather than value-investor).
My background: I’m currently working in USA and plan to come back to India (can’t wait!) in 2017. ~50% of my current equity investments are done using no-load index funds or ETFs (typically Vanguard funds … very low expense ratio – 0.01% to 0.4%, based good US & International benchmark-indices).
Here is break-down of my investments –
30% – Active funds {both US and international}
20% – Fixed deposits (~8.75% interest)
10% – US S&P 500 index funds
10% – US Small&Mid-Cap index funds
5% – US REIT index-funds
5% – World REIT index-funds {ex US}
10% – Emerging Markets index-funds
10% – Total International index-funds {ex US}
I have mainly followed Malkiel’s – “A Random Walk Down Wall Street” ….and have recently begun reading Graham’s – “Intelligent Investor” and Fischer’s – “Common Stocks and Uncommon Profits”, for my entry into Indian stock market {I have till now stayed away from stocks since my investments amounts are too small to justify US brokerage fees}. India unfortunately is other way around ….high expense ratios for index as well as active funds …whereas stock trading is cheaper.
I would like to know your thought on how can beginner (me) start investing in India.
Objective is to do the same with Indian investment vehicles –
• Get decent returns (say ~10-15% or more?) with low risk, low cost, low-involvement “core investments” {say ~50% of your capital}.
• Try to maximize performance using stocks, active funds etc (~30% of your capital) … where you have to keep reviewing weekly or monthly {as opposed to once each quarter or year}.
• Is it worth it to invest globally from India? (Are any decent investments available ?)
Also, how do investors in India –
• Invest globally? {less than $10,000 in each individual investment}
• Are there any REITs? ….or good vehicles to diversify your equity investments?
Thanks for sharing about you Aditya! As for your first question on how you can start investing in India, well given the experience you already have as an investor, it can be a mix of good MFs and direct stocks, which you can learn to analyse over a period of time. That’s for your “core” capital. I can suggest anything for the other 30%. As for investing globally, yes you can do. There are some MFs that help you own international stocks.
As for the second question, I have rarely seen Indian investors invest in international stocks. This is largely given that the opportunity cost of not investing in India is way too high for them to consider investing globally.
As for REITs, nothey do not exist in India as of now.
I hope this helps. Regards.
When starting out in the stock market, your best bet is to invest in a few high quality and popular stocks.
You don’t need to include 20 or 30 different stocks in your portfolio. Rather, start to get a feel of how the market works by only selecting a few promising options at one time.
I have tested the returns of CNX 500 over the 14.5 years of data available through NSE website. The daily rolling 5 year return for any 5 year period for the data range of 14.1 years has a median of 16.9%. And this is not total return i..e dividend not included. BSE 500 has an even better number with a rolling 5 year median return of 17.9%. The 10 year numbers are even higher. By comparison, NIFTY over the same period of data (admittedly a different data range altogether!) has provided a rolling 5 year median return of 8.6%. While the CNX 100 and BSE 100 outperform sensex and nifty, they also provide a lower rolling 5 year return than their 500 stock counterparts.
It is difficult to tell from these numbers of course, whether the CNX 500 will outperform CNX Nifty over the long-term, because 14.1 years is not even 2 ten year periods of data. So I would not want to make long-term conclusions. However, I think there is good reason to expect such a trend. After all, the market is bound to become more efficient, not less. Moreover, of the 500 stocks covered, the appreciation potential of the last 400 companies, despite the lower weight, should contribute greater and greater proportion of returns over the long periods of future to come. This much is certain; paying an extra 0.6% to Goldman (if you go for the direct plan, not distributor) over and above the index fund average, is worth it for the 500 stock coverage. Till date, the S&P 500 is the gold standard benchmark to capture US equity performance; I expect India, no matter how large it grows, to be adequately captured by CNX 500.
Most of the above comments are looking at point to point returns, and short horizons at that. Moreover, looking at past performance is quite dangerous, especially with a long-term future. If I had a 5 year horizon, I would go with Prashant Jain / other good quality funds. But I have a 20 year horizon. I see no reason at all to go with any fund manager, because there is absolutely no guarantee that the market will not become increasingly efficient over the next 20 years. In fact, I would be amazed if it didn’t. The alpha we have seen over the last 10 years should dissipate gradually over the next 10 to 20 years. After all, the US went through exactly the same phenomenon through the last century. And there’s a huge difference for us: the entire world markets are following us to some extent, and their interest will only increase with every year of alpha. That’s a certain systematic driver of efficiency.
Finally, advocating that Indian investors face too high an opportunity cost to invest internationally ignores the real risk of tail events and remote possibilities. Mathematically, India is just one country. A poor, corrupt, developing country at that, which has a history of derailing reforms and growth while also shifting into third gear rather erratically, like any other developing country. True, it has immense potential, but also potential to fail. I see no reason why a smart investor should not accept the tax disadvantages and invest about 25 to 40% of her portfolio overseas, in China, Indonesia, Malaysia and the other ten or so countries which are projected to return stellar returns to investors. Through cost-effective ETFs, minimal investment floors (10k$ with certain brokerages) and discount brokerage options, not to mention the currency diversification obtained, investors should see decent returns that also smooth the volatility of their portfolios due to the decreased correlation between asset classes.
I agree with Veera’s reasoning above. Good low-cost index funds both domestic & international is something that Indian investors need (specially with INR falling so drastically).
Also, I now no longer think index fund is an automatic mechanism to buy high and sell low (This is too simplistic).
Index funds do automatic momentum investing (sort of) ……. e.g. when a stock rises enough to be included in the index ….there is often a solid-fundamental reason for it’s rise, and it often continues to do well. We have a similar case when stock is dropped out of the index.
Isn’t there an inherent connection between investing with say 200-day moving average and index-fund based investing ?
Provided you have good broad benchmark indices (small cap, mid cap, large cap) ….I see no reason for a newbie investor to invest anywhere else (except for learning purposes).
E.g. How do US-based small-cap value index funds work ? {e.g. NAESX}. Can something similar work in India ?
Aditya / Veera,
Index funds are not buy high and sell low… Unless someone proves me with data… If i hold all index constituents then i don’t change unless the constituents change… Here is the list of the changes in the last 3 years….
Date of Inclusion Securities Included Securities Excluded
01-04-2013 INDUSINDBK SIEMENS
01-04-2013 NMDC WIPRO
9/28/2012 LUPIN SAIL
9/28/2012 ULTRACEMCO STER
4/27/2012 ASIANPAINT RCOM
4/27/2012 BANKBARODA RPOWER
10/10/2011 COALINDIA RELCAPITAL
3/25/2011 GRASIM SUZLON
I asked this to Vishal no response for the last 1 year… Probably goes against his approach of people buying individual stocks :-)…
I will buy Mutual funds when they invest in mid and small cap as we dont have specific index funds are ETF for mid and small caps except nifty junior…
When it comes to ETF Nifty Junior out performs nifty across mkt conditions…
– Jan’2008 to 30-Jun-2013 Nifty SIP return for 66 months is 7.63 %
– Jan’2008 to 30-Jun-2013 Nifty Junior SIP return for 66 months is 10.61 %
As a small investor large volatility helps me more opportunities to buy for long term
I reposted my comment here —–
Hi Vishal,
1. Index funds buy high, sell low – Testing this with an example.. If all the holders bought last year and they are not buying anymore the fund will not purchase anything and if the fund represented Jan 2011 index it will be same in Jan 2012 except if new stocks go to the index right ? Am i missing something ? In other words tracking error will not create significant Buy high and Sell low… I agree Kicking the funds is different and you explained that in point number 3.
2. Agreed.
3. Agreed. Remove Satyam from your graph as Raju fooled everybody including the best fund managers like Prashant Jain 🙂
Thanks
Jai
Reply
Hi Vishal,
I find points 2 & 3 to be valid but I disagree with the 1st point.
Let me make my point with numbers. Lets say there is an index of 10 stocks with equal weights. Lets say Rs 1,00,000/- is invested in it (i.e. Rs 10,000/- in each stock) Assume it to be close ended. Now lets say Stock A goes up by 10% & the others remain flat. Now the value of the fund is Rs 1,10.000/-. Now the fund manger will have to sell stocks worth Rs 9,000/- & invest Rs 1,000/- to maintain the same weights. I.e. now Rs 11,000/- is invested in each stock.
So here the fund manager has booked profit & invested in the shares that are still selling low compared to Stock A.
So how is it Buying high, Selling low?
Made a mistake in the example Stock A doubles.
what has been the returns for nifty bees annualised since inception..also the returns for bank bees and junior bees…
why do we not have etf for pharma, fmcg, and IT…. what are the 10 year returns for cnx pharma, cnx fmcg and cnx IT
For an indian investor… it will not be worth investing outside india etfs coz… bank fd in india is 9 to 10 %…and s&p 500 would historically deliver lower than that…( for us citizens their fd rates are much lower )
Incorrect analysis. Please add impact of USD VS INR change (I have had a very painful personal experience of converting $ and parking them in Bank FD with just 9.75% interest in 2012-2013 ….as my plans to buy house in India didn’t materialized). Return on investment (ROI) needs to be properly scaled with inflation while comparing numbers globally…….. their is no point feeling smug about higher % returns ….when cost of living has shot up drastically and INR has weekend. Not to mention dividends …… tax saving …..and other subtleties on real world investing.
the goldman cnx500 fund..can it be bought on nse by the broker like a share ?
In July 2014, I had posted the comparision of returns of Index funds vs active funds (under comments). As of Jan 2015, I thought of updating the same just to check whether our judgement of investing in active fund over index fund is correct or not. The below given data once again proves the point that it is worth to pay fees for active funds and earn a higher returns. The comparision is shown here below, also I have included the value of 1Lacs based on the returns provided to see the actual difference in amount:
10Years Return for :
Franklin India Index NSE Nifty 15.04% P.A (Rs.1 Lac invested = 4,05,965 after 10Years)
Franklin India Bluechip 18.24% P.A (Rs.1 Lac invested =5,34,126)
Sensex15.48% PA (Rs.1 Lac invested =4,21,762)
Franlin India Prima Plus 21.10% P.A (Rs.1 Lac invested = 6,78,330)
CNX 500 Index 14.28% PA (Rs.1 Lac invested =3,79,928)
QUantum LTEF – N/A
7 Years Return for :
Franklin India Index NSE Nifty 4.38% P.A (1,34,996/-)
Franklin India Bluechip 8.32% P.A (1,74,968/-)
Sensex 4.52% PA (1,36,268/-)
Franlin India Prima Plus 10.3% P.A (1,98,622/-)
CNX500 Index 3.39% PA (1,26,284/-)
Quantum LTEF 11.92%PA (2,19,965/-)
5Years Return for :
Franklin India Index NSE Nifty 10.08% P.A (1,61,637/-)
Franklin India Bluechip 13.03% P.A (1,84,488/-)
Sensex 9.8%P.A (1,59,592/-)
Franlin India Prima Plus 17.03% P.A (2,19,526/-)
CNX500 9.65% PA (1,58,505/-)
Quantum LTEF 15.56%PA (2,06,080/-)
3Years Return for :
Franklin India Index NSE Nifty 21.82% P.A (1,80,782/-)
Franklin India Bluechip 22.44% P.A (1,83,556/-)
Sensex 21.56%PA (1,79,627/-)
Franlin India Prima Plus 30.09% P.A (2,20,156/-)
CNX500 23.56% P.A (1,88,639/-)
Quantum LtEF 26.26% PA (2,01,278/-)
1Years Return for :
Franklin India Index NSE Nifty 34.71% P.A (1,34,710/-)
Franklin India Bluechip 41.09% P.A (1,41,090/-)
Sensex 33.51% PA (1,33,510/-)
Franlin India Prima Plus 61.55% P.A (1,61,550/-)
CNX500 41.61%(1,41,610/-)
Quantum LTEF 41.95% (1,41,950/-)
Regards
In the above comments, the last comment was posted on July 2012 and not on July 2014.
So what is the recommendation then? Should Index funds form a major part of the portfolio? Though the temptation is to replace PPF contributions with Index funds.
This was really an eye opener!!! Thank you so much!!!
Hi all, the post and the comments really share a wealth of knowledge.
I would like to add the point that there are literally 100s of Funds being managed by Active fund managers and comparatively much lesser Index Funds.
Also, when Fund managers typically pick 10-15 good companies or Stocks, the leverage or Risk-Reward ratio is quite high i.e. if those companies do well, these Funds will do well, but if they don’t, the funds will go down equally fast.
Thus, there will always be some Funds that do better than Index Funds and they will be highlighted for all to see, however the Index funds are much safer bet and will always be in median range.
The real questions is do Index Funds beat vast majority of Funds (managed by active Fund managers) and do individuals who are not sophisticated investors have the capability to find Best (or better than Index Funds) performing Funds ?
Sadly Vishal you get it totally wrong on Index Funds.
1. “What is more, as I’ve explained above, the way the Sensex (or the Nifty) are constructed makes them just a shabby collection of big companies/expensive stocks.” This Shabby collection also includes HDFC Bank, Bajaj Finance, TCS etc and you have chosen to cherry pick.
2. The stock market has a pareto 80/20 distribution where 20% of stocks account for 80% of the gains. (link here. and i have done this study for india also)
3. Index is a rebalancing excercise which overcomes human bias. It ensures winners stay and losers go.
4. And last see the link of the latest SPIVA reports. No Alpha in large caps and its a coin toss even if you manage to find a winning fund. Same is happening in Midcaps. In the US. 48% of equity investments have moved to index funds. And even a narrow Nifty 50 and/0r Nifty Next 50 has beaten most mutual funds.
I see that the key arguments made in this post are quite dated. Wouldn’t that change in light of the fact that we now have access to a well-diversified Index funds (e.g. Nifty 500) that essentially buy the entire market?
Buy index fund and hold it forever……John bogle
Hi Vishal,
All great points. A big fan of your writings, teachings, You Tube videos. Your blog, email posts, The one percent show all is just gold mine for someone like me. I have been investing in the stock markets through SIPs in mutual funds since 2008. No other assets nothing. Only high rate of savings & all the savings have been going in MFs. Have made more than satisfactory returns over the last so many years. For the same reasons you mentioned above, don’t prefer index funds. But if it’s only about large cap mutual funds, I think one needs to rethink going forward. Disclaimer: I don’t invest in large cap funds.
Cheers!
Akshay