How to use Index Funds? #investment

Summary

In this episode of 'Investors Hangout,' Dendra Kumar discusses the growing popularity of index funds, emphasizing their simplicity, low cost, and the significant inflow of funds due to government mandates. He advises a long-term investment strategy, suggesting a basic portfolio with a mix of aggressive hybrid funds and index funds like Nifty or Sensex. For more sophistication, diversify across market caps and consider international funds. Selecting the right index fund involves comparing costs and tracking errors. Small cap funds are recommended for the long term but come with risks, as they can fluctuate significantly.

Takeaways

• 📈 **Index Funds Popularity**: Index funds are gaining popularity due to their simplicity, low cost, and the increasing number of options available.
• 💼 **Long-Term Investment**: The script emphasizes the importance of investing in index funds for the long term, highlighting their resilience despite market fluctuations.
• 💡 **Simplicity in Investing**: Dendra Kumar suggests keeping investments simple, such as allocating 25% to debt funds and 75% to Nifty or Sensex funds for a basic portfolio.
• 🌐 **Full Market Exposure**: For a more sophisticated portfolio, diversify across large-cap, mid-cap, and small-cap index funds to achieve full market exposure.
• 🔄 **Portfolio Churn**: Even though index investing is considered passive, the composition of the portfolio can change as the constituents of the index change.
• 🌍 **International Diversification**: To further sophisticate a portfolio, consider adding international funds like the NAS 100 index for global diversification.
• 📊 **Total Market Exposure**: For low-maintenance portfolios, consider investing in a total market exposure index fund that provides a well-spread diversification across all market sectors.
• 🔍 **Choosing the Right Index Fund**: When selecting an index fund, focus on the cost (expense ratio) and the tracking error to ensure the fund closely replicates the index.
• 🚫 **Avoid Overthinking**: The script advises against overthinking the choice between different index funds like Sensex or Nifty, as the long-term difference is minimal.
• 📉 **Risk of Small Cap Funds**: While small cap funds have high potential returns, they also come with higher risk, as seen in the 2008 market crash where they fell by 58%.
• 🏆 **Performance of Small Cap Funds**: Historically, small cap funds have outperformed other diversified vehicles over the long term, with impressive returns over 10 and 20 year periods.

Q & A

What is the main purpose of the 'Investors Hangout' video series?

The main purpose of the 'Investors Hangout' video series is to educate viewers on savings and investment issues, with a focus on index funds as a means to balance low risk and good returns.

Why have index funds become popular recently according to the transcript?

Index funds have become popular due to their simplicity, low cost in terms of asset management, and the increased variety of index funds available in the market, which has led to greater awareness and investment, especially after the EPFO started investing in equity through index funds.

What is the basic rule of investing in index funds as mentioned in the script?

The basic rule of investing in index funds is to invest for the long term, using a systematic investment plan (SIP), and to avoid panic selling during market downturns.

How does the script suggest building a simple yet robust portfolio using index funds?

The script suggests investing 25% in a debt fund and 75% in a large-cap index fund like Nifty or Sensex for a simple and robust portfolio, which is low cost and easy to understand.

What is the recommended allocation for a more sophisticated portfolio in terms of market capitalization?

For a more sophisticated portfolio, the recommended allocation is 50-70% in large-cap, 20-40% in mid-cap, and 10-30% in small-cap index funds, depending on the investor's risk tolerance.

Why is it suggested to include an international fund in a sophisticated portfolio?

Including an international fund, such as a Nasdaq 100 index, provides diversification and exposure to global markets, which can help in managing risk and potentially enhancing returns in a sophisticated portfolio.

What is the significance of the total market exposure index mentioned in the script?

The total market exposure index is significant as it provides a well-spread diversified exposure to all sectors and segments of the market, making it suitable for investors who want a low-maintenance portfolio with broad market coverage.

How should one choose the best index fund according to the transcript?

One should choose the best index fund based on the lowest cost (expense ratio) and the lowest tracking error, which can be found in the Index Fund scorecard provided by the mutual fund Insight magazine or the website.

What is the viewer's question about investing in small-cap funds for a 15-year period?

The viewer's question is whether it is okay to invest in small-cap funds for a long term of 15 years, considering the risks and potential rewards.

What is the response to the viewer's question about small-cap funds for long-term investment?

While small-cap funds have the potential for high returns, as evidenced by their historical performance, they are not recommended for new investors due to their high volatility. However, for those who can withstand market fluctuations and maintain a diversified small-cap portfolio, they can be a winning investment over the long run.

What is the historical performance of small-cap funds over different time periods as mentioned in the script?

Over the last 10 years, small-cap funds have given a return of 23%, the highest among diversified vehicles. Over the last 20 years, the small-cap total return index has been the best-performing index, and even in the last five years, it has been the best-performing fund with nearly 25% returns.

Outlines

00:00

📈 Introduction to Index Funds and Their Benefits

The first paragraph introduces the concept of index funds, emphasizing their growing popularity due to simplicity, low cost, and the impact of government mandates on their investment. Dendra Kumar discusses the importance of long-term investment strategies and the potential of index funds to offer a balance between risk and returns. The speaker suggests a basic portfolio strategy involving aggressive hybrid funds and a mix of debt and equity investments, highlighting the need for simplicity and consistency in investment plans.

05:00

🤔 Choosing the Right Index Fund and Long-Term Investment Considerations

The second paragraph delves into the decision-making process when selecting an index fund, focusing on the minimal long-term differences between various index funds like Sensex and Nifty. The speaker advises not to overthink the choice between these funds, as the cost and tracking error are more critical factors. The importance of low expense ratios and minimal tracking error is underscored, with a recommendation to consult an Index Fund scorecard for guidance. Additionally, the paragraph addresses a viewer's question about the suitability of small-cap funds for long-term investment, noting the potential high returns but also the risks involved, especially for new investors who may not have experienced market downturns.

Keywords

💡Index Funds

Index funds are a type of mutual fund that aims to replicate the performance of a specific index, such as the S&P 500 or the Nifty 50. They are passively managed, meaning they do not actively trade stocks to outperform the market. In the script, index funds are highlighted as an attractive option for investors looking for a balance between low risk and good returns. The speaker discusses the simplicity, low cost, and increasing popularity of index funds, particularly in India, due to their ease of understanding and the large inflow of money from the Employee Provident Fund.

💡Asset Management

Asset management refers to the professional management of various financial assets such as stocks, bonds, and real estate. In the context of the video, it specifically refers to the cost of managing an investment portfolio, which is highlighted as being low in index funds. The script emphasizes the importance of low asset management costs as a key factor in choosing index funds, as they can significantly impact the overall returns of an investment.

💡Long-term Investment

Long-term investment is a strategy where an investor holds assets for an extended period, typically years or decades, to achieve financial goals. The script emphasizes the importance of investing for the long term, especially in index funds, as they are not immune to market fluctuations. The speaker advises against panic selling during market downturns and encourages a steady investment approach through systematic investment plans (SIPs).

💡Aggressive Hybrid Fund

An aggressive hybrid fund is a type of mutual fund that aims to achieve high returns by investing in a mix of equity and debt instruments. In the video, the speaker suggests a simple investment strategy involving allocating 25% of funds to a debt fund and 75% to an equity index fund, such as the Nifty or Sensex, to achieve a balance between risk and return.

💡Market Exposure

Market exposure in investing refers to the extent to which an investment is affected by movements in the overall market. The script discusses strategies for achieving full market exposure through a diversified portfolio of index funds, including large cap, midcap, and small cap funds. This approach helps investors spread their risk across different segments of the market.

💡Index Constituents

Index constituents are the individual stocks or securities that make up a particular index. The script mentions that while index investing is considered passive, the composition of an index changes over time, which in turn affects the holdings of an index fund. This dynamic nature ensures that an index fund's portfolio is continually updated to reflect the current market.

💡International Fund

An international fund is a type of investment fund that invests in securities from multiple countries outside the investor's home country. The speaker in the video suggests adding an international fund, such as a Nasdaq 100 index fund, to a portfolio for diversification. This can help investors gain exposure to global markets and potentially reduce risk.

💡Total Market Exposure Index

A total market exposure index is designed to provide broad exposure to the entire market, rather than focusing on a specific segment like large cap or small cap. The script mentions such an index as a low-maintenance investment option for investors who want a simple, diversified portfolio that reflects the overall market.

💡Expense Ratio

The expense ratio is the percentage of assets that a mutual fund charges its shareholders for expenses. It is a critical factor in evaluating the cost-effectiveness of a fund. In the video, the speaker advises investors to look for index funds with a low expense ratio, as this can significantly impact the net returns of an investment.

💡Tracking Error

Tracking error measures how closely a fund's performance follows the index it is designed to replicate. A lower tracking error indicates that the fund closely mirrors the index's performance. The script emphasizes the importance of choosing an index fund with a low tracking error to ensure that the fund's performance aligns with the intended index.

💡Small Cap Fund

A small cap fund is an investment fund that focuses on smaller companies with a market capitalization of less than $2 billion. The script discusses the potential high returns of small cap funds over the long term, but also warns of their volatility and the risks associated with investing in them, especially for new investors.

Highlights

Index funds offer a balance between low risk and good returns.

Simplicity is a key reason for the popularity of index funds.

Low asset management costs are a significant advantage of index funds.

The rising popularity in India is due to mutual fund companies creating a variety of index funds.

Large inflows into index funds are driven by the EPFO's mandate to invest in equities.

Investing in index funds should be done with a long-term perspective.

Index funds are not immune to market fluctuations; investors should maintain a steady SIP.

A simple portfolio strategy involves investing 25% in debt funds and 75% in Nifty or Sensex funds.

For a more sophisticated portfolio, consider a full market exposure with allocations to large cap, midcap, and small cap index funds.

Index funds provide automatic portfolio rebalancing as index constituents change.

Adding an international fund like Nas 100 can further diversify a portfolio.

A low-maintenance portfolio can be achieved with a total market exposure index fund.

Choosing the best index fund involves considering cost and tracking error.

Expense ratio and tracking error are key variables in selecting an index fund.

Investing in small cap funds can be beneficial over the long term, but they carry higher risk.

Small cap funds have shown high returns over the last 10 and 20 years, but they can be volatile.

New investors should be cautious about investing in small cap funds due to their volatility.

Continued investment in small cap funds can yield higher returns if one can withstand market downturns.

Transcripts

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hello and welcome to investors hangout

this weekly interaction to help you

learn and understand savings and

investment issues is brought to you by

Adas and life mutual fund and value

research now index funds present a

attractive option to investors looking

to strike a balance between low risk and

good returns so in today's episode let's

learn from dendra Kumar how to

effectively harness the potential of

index funds to build a robust portfolio

welcome dendra thank you so let's start

today's discussion with uh delving into

the reasons behind the popularity that

index funds have been gaining off late

one is that

Simplicity uh it's very easy to

understand here is an index this is how

it is constructed and if you invest in

this fund it'll be taken care of the

normal mutual fund arena is very

complicated wide variety of funds and

you know many things to choose from of

course index category is also getting

complicated but by and large it is is

easy to understand secondly the cost the

asset management that you get here is at

such a low cost and third is that you

know the rising you know popularity in

India is not in terms of investors are

queuing up to invest in these funds

right just because you know mutual fund

companies are creating a wide variety

large number of different kind of index

fund that we see that you know there is

greater noise or you know around them

but uh we have seen the big money

flowing into mutual fund into index fund

entirely because the employe Provident

fund money once it was mandated by the

government that epfo should invest money

in equity The Chosen vehicle was index

fund that is why we see the money Index

Fund or active fund one should not

forget the basic rule that you should be

investing for the long term you should

be investing you know being Index Fund

they are not insulated from all the wild

V character they will go up and down so

do your sip keep it simple uh you can do

it at different levels but uh uh your

long-term money and doing periodic

investment and making sure that you

don't panic at the worst of times is

still important now moving on how to use

uh index funds to build a robust

portfolio to begin with you should keep

it very simple as I say that invest in a

u aggressive hybrid fund so put 25%

money in a in in a in a debt fund and

75% to a Nifty or a sensex fund that is

that is it it'll keep it very simple

it'll be very low cost very easy to

understand and you can be at it for next

you know the initial 3 to five years and

you will get 90% of the benefit maybe

more if more and more fund are

struggling to beat the index second is

that you know making it a little more

sophisticated getting a full Market

exposure and there are multiple ways of

going going about it you ideally one

should have you know 50 to 70% into

large cap M 20 to 40% depending on your

own tolerance into midcap and 10 20% 30%

into small cap so you decide on your

allocation and choose one index fund and

of your 100 rupee 50 into index into

into nifty 50 into Nifty or sensex 30

into any other you know midcap index and

uh remaining into small cap index and

you here you have all you know all cap

index uh which you don't have to worry

about and there will be churn within the

portfolio because these index though

index investing is being referred as

passive investing but index constituents

change and when index constituents

change your portfolio will change right

though you will continue to hold BC

small cap 250 index or NSE 250 but uh 50

of the companies within that would have

undergone a change you may not you may

not notice so you are getting a first

class portfolio then if you want to make

it even more sophis

phisticated then you can add a

international fund to it a Nas 100 index

is available or a uh fund of fund is

available be mounted on that index or

you have a Fang plus index available or

you have a Hing index available uh if

you want to keep it a very low

maintenance portfolio then you can well

go for a uh you know a

completely different vehicle of an index

which is you know there is an index

available which which is not very

popular index but a total Market

exposure index it is you know most of

our index or the large index or the

popular index they tend to be large gap

heavy this is a fund this is a index

where there is a substantial exposure to

all the sectors or or reasonable well

spread Diversified exposure to all the

sectors and all the segments of the

market if you want to really

uncomplicate your investment journey and

you unable to decide on which fund but

you know that you are this is this is a

money which you are unlikely to need for

5 10 years invest in the large

index fund that is it and keep investing

month after month all right now we come

to the question of with so many Index

Fund options available out there how

should one choose the best suited for

them there isn't much of a difference

you know if you choose sensex or Nifty

it doesn't make a difference it and it

certainly doesn't make a difference over

a 10 15 year period And even if it does

make a difference of few basis point or

one or two percentage point it can't be

anticipated you can't do much about it

so don't bother don't think too much

about it one is that there are but there

is a there is a variable there are

variables based on which you should make

a choice look at our website or look at

our mutual fund Insight magazine there

is a Index Fund scorecard and two

variables one is the cost cost is

Paramount everything is being equal lowc

cost fund will give you better returns

right and these costs are so compelling

so attractive you know sometimes you're

getting this Nifty Index Fund at

0.05% it's almost free H uh likewise so

look at Cost look at the expense ratio

and the second is the tracking error I

would like that once I have chosen an

index fund then that fund index fund

better replicates the index to the best

of its ability right or to the extent

possible so choose the tracking error

which choose the fund which has the

lowest tracking error so combination of

expense and tracking error in our from

our uh Index Fund scorecard all right

then before we end today's episode we

have a viewer's question that we would

like to answer V asks for long term say

for 15 years is it okay to go for a

small Cap Fund it is okay to go for a

small Cap Fund but the problem is that

it is not okay for a new investor

because uh anybody who has come to the

market in the last three four years five

years he would have seen the only the

upside of the small cap but you know you

should not forget that in

2008 the small caps fell freely they

fell by 58% so it is not meant for

everybody

but over the long run if you are

carrying a diversified small cap

portfolio you will be a winner look at

the small Cap Fund Universe over the

last 10 years it has given a return of

23% which is the highest among the

Diversified Vehicles then look at the

last 20 year performance the small cap

Total return index is the best

performing index uh over the last 20

years even if you look at you know last

five years it is the best performing

fund with nearly

25% and that is true for the index as

well as the actively managed fund so of

course these are the good times for the

small capab there is a Euphoria around

small capab and it and Euphoria will not

continue forever forever there'll be bad

times as well but if you withand those

if you can withstand and you know if you

can actually withstand those period

continue investing these returns could

even be higher all right then hope vode

you've got your answer so keep watching

the space for more information if you

like the show do subscribe to our

YouTube channel take care bye for

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now

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