Investments in index funds should be driven by one’s risk appetite and despise under performance in the near future.
Diversified Equity Fund: Sensex, a leading stock market barometer, is hovering around the level of 35000. It has bounced back from the level of 25639 which it touched in March this year. While the year till date (YTD) return is a negative 13.75 per cent, the 3-year return of the index is nearly 13.75 per cent. While we are still in the middle of the COVID-19 pandemic, the big reversal in stock prices is something both the existing and the new investors are looking for.
The actual recovery in the corporate earnings may still be a few quarters away and the current liquidity and signs of economic recovery in some global economies could be some of the factors taking the Sensex and Nifty to higher levels from their recent lows. “Investors should be wary of the probability of the market cascading down further in the next quarter. New investors should avoid panic and get into the equity market with wise options in mind,” says Sonam Chandwani, Managing Partner at KS Legal & Associates.
If you are a new investor looking to start investing through mutual funds, here is a primer.
Investing through equity mutual funds makes the task a little easier and simpler for you as compared to directly picking stocks. One of the many advantages is that with the same amount of money, it gives you diversification across different stocks, sectors and market capitalisation. Stock prices can move 5 to 10 per cent or more on a given day while the same stock within an MF scheme may not have that much impact on the fund’s NAV’s.
Index fund or Diversified fund
A diversified fund is a typical MF investing across different stocks and sectors. The diversification can be across market capitalisation but generally, there are large-caps, mid-caps and mid-cap funds. This categorisation helps investor while investing in them. The allocation into each stock or industry is, however, the privilege of the fund manager of the scheme. The actual weightage into each stock, is, therefore, as per the calls taken by the fund manager.
An index fund, on the other hand, is also a diversified fund but with a big difference. Here, there is no call taken by the fund manager as to where to invest and which stock to pick. The allocation is on the basis of the weightage of the stocks in the index that the fund is benchmarked to. For example, if an index fund tracks NIFTY50, the index fund will also allocate funds in the same weightage as per the index. “Index funds can be a good option at this point in time with the less associated market risks,” says Chandwani.
Impact on return
In a diversified fund, the returns will largely depend on the fund manager’s acumen. There is a possibility of the scheme beating the benchmark as well the risk exists on the downside. However, the return in an index fund is largely in line with the index or the market, subject to tracking error and expense. “Investments in index funds should be driven by one’s risk appetite and despise under-performance in the near future. Investors unable to decide upon quality equity mutual fund schemes can readily opt for index funds,” says Chandwani.
Source: BSE website – Sensex YTD ( As on June 24, 2020)
Where to invest
Investing in MFs is not at all for speculative and shorter-term goals. One needs to keep investing for goals which are at least 7 years away and also keep a de-risking strategy in place nearing the goals. As a new investor, an index fund is often recommended by financial planners. It gives a head-start towards investing in stock markets. Over time, as and when you become comfortable, one may add an actively managed diversified large-cap fund and mid-cap scheme.
“Important to understand market sentiments and investor confidence levels. In volatile markets where one cannot see long term, index funds are the right way to invest in markets. As markets stabilise investors need to look for outperformance to alpha and need to look for active funds to get outperformance. In the current market, staggered investing through active funds will give better returns till markets reach pre COVID levels over a one-year time frame,” says Nitin Rao – CEO, InCred Wealth.
Invest with long term goals in mind and keep not more than 3-5 schemes in your portfolio. And importantly, remember that volatility is inherent in stock markets and, therefore, every time, markets fall by 500 or 1000 points, keep your focus on the long term goals.