Such funds tend to own a basket of actively traded stocks, are low on cost and are not personality focused.
Such funds tend to own a basket of actively traded stocks, are low on cost and are not personality focused.
Thousands of investors from around the world are the American conglomerate Berkshire Hathaway Inc. attend its annual general meetings and read out letters to its shareholders.
They hope to gain investment wisdom from Warren Buffett, the chairman and CEO of Berkshire, who has become one of the world’s richest men by owning shares in great American companies.
But one advice that Mr. Buffett repeats at every meeting, whenever asked for stock tips, is to invest in an index fund instead. “Constantly buy an S&P 500 low-cost index fund. Keep buying it through thick and thin, especially through thin,” he once quipped. Mr. Buffett has also said that after his death, he told his trustees Directed to put 90% of his assets in an S&P 500 index fund for the benefit of his wife. This may sound like a strange piece of advice, coming from a seasoned investor who has actively held equity stakes in American companies. Having made over $100 billion from buying and owning it, Mr. Buffett has solid reasons to recommend index investing to people who are not professional investors.
Whether you are an Indian investor who is new to the stock market or someone in the middle of your career who does not have the time to pick up stocks or funds, Mr. Buffett’s advice may apply to you. If you are willing to participate in the return potential of equities without managing your portfolio, you can only take the passive route. Passive investing involves buying into index funds or exchange-traded funds (ETFs) that represent a broad market index, such as the Sensex 30, Nifty 50, Nifty 100 or Nifty 500, that own the same basket of stocks in the index. .
the biggest owner
One of the most difficult choices for an investor looking to buy equity is to choose the right stock or equity fund to buy. Social media, WhatsApp and Telegram channels are chock-a-block with stories of how investing in shares of Infosys or Asian Paints 20 years ago would have made you rich today beyond your wildest dreams. But such stories are shaped from behind. For every stock that delivers double-digit gains over the long run, there are dozens that don’t even generate savings-bank returns.
At a Berkshire meeting in 2021, Mr Buffett explained that the future is going to be a ‘wonderful industry’ than just figuring out what stocks to choose from. “There were at least 2,000 companies that entered the (US) auto business (in the early 1900s) because it clearly had this incredible future, but in 2009, there were three remaining, two of which went bankrupt. ”
Investors who have been in the Indian markets since the nineties will have similar stories about textile giants like Century Textiles and Bombay Dyeing, which used to be part of the Sensex but are now a shadow of their former selves.
If you invest in actively managed mutual funds instead of index stocks, a professional manager selects the stocks for you. But you’ll still need to choose between hundreds of actively managed equity funds, sliced and diced based on their market cap, style, sector and theme.
An index fund helps you hold a basket of the largest and most actively traded stocks in the economy by market value. Market indices like Nifty 50, Nifty 100 or Sensex 30 act as a barometer of the economy and market. Therefore, they are designed to own, at any given time, the largest and most active shares in the market, from a listed universe of 5,000-odd stocks. Companies or sectors that do not perform well over time or fall off the radar are automatically replaced by new ones that are growing rapidly. Investing in Sensex 30, Nifty 50 or Nifty 100 index funds is a bet on the biggest companies of the Indian economy.
Less cost
Globally, hedge fund managers are considered the smartest individuals in finance, juggling stocks, bonds, exotic instruments and derivatives with the aim of delivering absolute returns in market conditions. In 2007, Mr. Buffett issued a challenge to the US hedge fund industry, saying it could not outperform an ordinary S&P 500 index fund over the next 10 years after fees.
The point Mr. Buffett was trying to talk about was the difference that fees can make in an investor’s long-term results. Hedge funds have traditionally charged fairly steep fees for their prowess, which include 2% of annual assets in addition to a portion of the profit above the hurdle rate.
Protege Partners, an advisory firm, took on the challenge of building a portfolio of hedge funds. But nine years later, in 2017, it was forced to throw the towel over the Buffett challenge. In the nine years to 2016, the S&P 500 index fund was up about 85%, while selected hedge funds managed to gain just 22%. When you invest in curated portfolios such as actively managed equity funds, portfolio management schemes (PMS) or small cases, you pay a fee to the portfolio manager to choose the best bets for your portfolio.
Management fees can take a significant bite out of your returns in the long run. Also, if the fund or portfolio you hold underperforms the market, you may need to sell it and switch to an outperforming option. This includes capital gains tax and brokerage.
Passive investing saves you both types of costs. One, because they only mimic an index and do not attempt any active stock-picking, index funds charge much lower management fees than actively managed funds. In India, index funds, if you invest directly, charge an annual fee of at least 10-20 basis points, while active equity funds charge 75 to 225 basis points. This makes an instant difference to your returns.
Two, because index providers regularly replace sectors and stocks in the index to reflect what’s in the market, you don’t need to churn your money frequently to save on capital gains tax.
no individual dependent
When you choose an actively managed equity fund, PMS or Smallcase, you are essentially betting on the investment skills of the person who is managing your money. But identifying the right fund manager to place bets is not an easy task.
Managers who outperform the market in one bull market may not deliver in another bull market. In India, it is also quite difficult to find fund managers who have been with a firm for more than 10 years. You can invest in a fund that impresses with its manager’s skills or track record, but it may leave the green pastures in the middle of your investment journey. A fund manager’s investing style and temperament can also contribute significantly to a fund’s ability to perform in market conditions.
When they leave, performance may go downhill or change dramatically. Investing in index funds automatically takes personal skills out of the equation, as your fund only owns stocks that fall within a broad market index.
Index investing is not a panacea, as the stocks in the index are chosen more for size, market imagination and liquidity than for their growth prospects or quality of management. But, for investors who lack the time or skill to make more nuanced choices, index funds are a hassle-free way to bet on the long-term prospects of the Indian economy.