Skip to main content

Invest in Index fund or diversified equity fund?

 

 

Is it time to invest your money in index fund or should you go in for a diversified equity fund? Here are the pros and cons


   IF YOU have put your money in the S&P CNX Nifty Index 5 years ago, there is a 70% chance that you would have made more money than by investing in a large-cap fund. According to S&P CRISIL SPIVA report for the year ended December 2009, over 70% of large-cap funds underperformed the S&P CNX Nifty Index over a 5-year period. But at the same time, with the Sensex reaching near-18,000 level, market experts are calling it a stock picker's market rather than one for the index investor. So, what should you, as an equity investor, do? To know the way forward, you need to answer some of the following three questions.


Where do you come from?


The answer to this question can make your life simple. Investors prefer to choose between active or passive styles of investing depending on their needs. It has been observed in developed markets that institutional investors such as pension funds looking for asset exposure prefer to stick to passive investing by opting for index investments. These investors are willing to commit their money for a long term. Liquidity remains a key parameter in any investment decision of these investors, which is ably addressed by index investing.


   The second segment of investors that would like to opt for index investing is known as 'asset allocators'. Once done with their risk profiling and investment needs, they prefer to allocate their money to various asset classes and hold on to them for a long period resorting to asset rebalancing at regular intervals. Index funds are preferred vehicles for many asset allocators. The rest of the investors, typically looking for alpha — the excess returns over the returns offered by the broad market — can look at actively-managed funds.


What ideology do you subscribe to?


While investing in the market, there is a need to have a sound foundation of a theory you subscribe to. Efficient market hypothesis (EMH) is a celebrated and equally-criticised theory in markets. EMH maintains that the financial markets are information-efficient. The prices of traded assets already reflect all the available information, and keep changing to accommodate any new information.


   In other words, stocks always trade at a fair value and factor in all possible information available in the market. Hence, no investor can buy an undervalued stock or sell an overvalued stock. There is no scope for an investor to beat the market in the long run by earning excessive returns than the returns offered by the broad market.

Take Your Pick

What's Your Style?

Active investment refers to a portfolio management strategy where the manager or investor makes specific investments with a view to outperforming a given benchmark market index. A good example can be a diversified equity fund, where the fund manager tries to beat the benchmark, say BSE Sensex, in the long term. Active investment indicates high churn, higher costs and achievement of alpha - the excess returns over market.


Passive investment Passive investment strategy involves buying a basket of shares with a long-term hold. The basket of stocks bought typically is an actively-traded benchmark representing broad market or a sector. A good example can be investing in an index fund in which the fund manager buys shares of companies in the same proportion as they enjoy in the underlying index. Passive investment indicates low activity, low costs and nearly the same returns generated by the index or the underlying basket.

Factors To Look At While Choosing An Index Fund

Tracking error How much the index fund's returns have deviated from the underlying index, is termed as tracking error. Zero or lowest tracking error is a good indicator of a good index fund.


Expenses: Costs are low given the little activity required to mimic the index by the investment manager. Lower the costs, the better it is for index investors.

 


Popular posts from this blog

Tata Mutual Fund

Being a part of the Tata group, the fund has the backing of a very trusted brand name with strong retail connect. While the current CEO has done an excellent job in leveraging the Tata brand name to AMC's advantage, it is ironic that this was just not capitalised on at the start. Incorporated in 1995, Tata Mutual Fund remained an 'also-ran' fund house for around eight years. Till March 2003, it had a little over Rs 1,000 crore in assets and 19 AMCs were ahead of it. But soon after that the equation changed. It was the fastest growing fund house in 2004 and 2005. During these two years, it aggressively launched six equity funds, two debt funds and one MIP. The fund house as of now stands at No. 8 in terms of asset size. This fund house has a lot to offer by way of choice. And, it also has a number of well performing schemes. Tata Pure Equity, Tata Equity PE and Tata Infrastructure are all good funds. It also has quite a few good debt funds. The funds of Tata AMC are known to...

UTI Mutual Fund

Even though only a few of UTI’s funds are great performers, this public sector fund house has many advantages that its rivals do not. It has a huge base of retail equity investors and a vast distribution network. As a business, it looks stronger than ever, especially in the aftermath of credit crunch. UTI is, by a large margin, the most profitable fund company in the country. This is not surprising, since managing equity funds is more profitable than debt. Its conservative approach and stable parentage is likely to make it look more attractive to investors in times to come. UTI’s big problem is the dragging performance that many of its equity funds suffer from. In recent times, the management has made a concerted effort to improve performance. However, these moves have coincided with a disastrous phase in the stock markets and that has made it impossible to judge whether the overhaul will eventually be a success. UTI’s top performers are a few index funds, some hybrid funds and its inf...

Salary planning Article

1. The salary (basic + DA) should be low. The rest should come by way of such allowances on which the employer pays FBT and you don't pay any tax thereon. 2. Interest paid on housing loan is deductible u/s 24 up to Rs 1.5 lakh (Rs 150,000) on self-occupied property and without any limit on a commercial or rented house. 3. The repayment of housing loan from specified sources is also deductible irrespective of whether the house is self-occupied or given on rent within the overall ceiling of Rs 1 lakh of Sec. 80C. 4. Where the accommodation provided to the employee is taken on lease by the employer, the perk value is the actual amount of lease rental or 20 per cent of the salary, whichever is lower. Understandably, if the house belongs to a family member who is at a low or nil tax zone the family benefits. Yes, the maximum benefit accrues when the rent is over 20 per cent of the salary. 5. A chauffeur driven motor car provided by the employer has no perk value. True, the company would...

8 Investing Strategy

The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks. Read on Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-...

Debt Funds - Check The Expiry Date

This time we give you an insight into something that most debt fund investors would be unaware of, the Average Portfolio Maturity. As we all know, debt funds invest in bonds and securities. These instruments mature over a certain period of time, which is called maturity. The maturity is the length of time till the principal amount is returned to the security-holder or bond-holder. A debt fund invests in a number of such instruments and each of these instruments would be having different maturity times. Hence, the fund calculates a weighted average maturity, which would give a fair idea of the fund's maturity period. For example, if a fund owns three bonds of 2-year (Rs 30,000), 3-year (Rs 10,000) and 5-year (Rs 20,000) maturities, its weighted average maturity would be 3.17 years. What is the big deal about average maturity then, you may ask. Well, knowing a fund's average maturity is important because it tells you how sensitive a fund is to the change in interest rates. It is ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now