Some sophisticated investors frequently question about index investing. The vital question is: Is it the right time for index investing? If you are expecting the experience of the developed markets, like those of the US, to get replicated in India, then switching to index investing looks unavoidable.
But according to our analysis, it is not the right for index investments yet. Also, we feel that it is not going to happen shortly too. The debate can go on, either in its favor or against it. The truth will be revealed only when it happens.
It is easy to convince yourself that the reasons for which you have been avoiding index funds will remain valid for years to come. But if you look at the past and draw a trend line accordingly, then you will come to a different conclusion. In earlier times, most of the equity funds used to beat the indices every year. So, investors preferred to invest sheerly depending upon the performance level. But today, the scenario is different. Now, index funds have started making sense.
Some people keep on asking this question every year. Should Indian investors start thinking about index investments seriously? It is better to ask this question periodically. The answers vary according to the period. That answer which was correct five years, may not be correct at present.
Normal mutual funds aim at beating the markets. They aim to acquire better returns than the market index. Some of them are capable enough. The rest is not. On the contrary, index funds aim at replicating the performance of an index. They do not aim for better or worse. Hus, a BSE Sensex based index fund will have the same 30 stocks which the Sensex possesses in exactly similar proportion. Investors who invest their money in such a fund will acquire returns that are exactly similar to those of the BSE Sensex.
Index funds can reverse the logic of mutual funds. The fund managers must work actively to provide individual investors with high quality, professional investment management. But, index funds follow the idea that fund managers do not possess that much expertise and it will be a wastage of time to consult them. The major factor that drives index fund performance is its low cost which is capable of translating into better returns for the investors.
Index funds have been a success in the western markets because active fund managers were unable to beat the indices irrespective of their high cost. The second reason is that index funds are capable of absolving the blames upon any advisor. If it performs badly, then it is not the fault of the advisor. Rather, it is the fault of the index. The third reason is the historical role of John Bogle (founder of the company) and Vanguard. Without Bogle's influence, passive investment would not have been possible.