Index funds are the way to go - Views on News from Equitymaster

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Index funds are the way to go

Sep 25, 2001

As the domestic equity market is witnessing one of its worst slumps ever, hapless mutual fund investors are finding a big hole in their investments that seems to be widening with every passing day. At a moment like this when the index is at one of its all-time lows, an index fund can be a good long-term investment proposition.

One does not need to be a seasoned investor in stocks and mutual funds to know that the best time to buy is when markets are low and sell when they are high. Right now markets are so low that any stock looks good. This is where investors need to be careful in stock picking. They need to be with the best bluechips, the leading lights in their respective sectors and stocks that will benefit most from a rebound in the sector. And this where index funds come in.

Index funds invest in stocks in the benchmark index (Sensex, S&P CNX Nifty) in exactly the same proportion as the index. So a Sensex-linked index fund will invest in Infosys, Hindustan Lever, Gujarat Ambuja Cements in the same proportion as the Sensex.

Index funds make sense mainly due to two reasons Ė you donít have to worry about beating the index as you are invested in it. Secondly as there is no Ďactiveí fund manager, the fundís expenses are low as the fund managerís fees constitute a large portion of the expenses.

Right now with the index at its bottom a lot of investors are exiting in panic. But you can be smart by investing in an index fund, because the index is so low that the only way seems up. Even if you arenít sure that the index has bottomed out and you donít want to take a chance with that, you can try investing in the systematic investment plan (SIP). So rather than investing all your money at this level, you can invest all that money over a period of 2-3 months. That way you will catch every drop in the index over this period.

However, index fund investors at this point need to be patient. Index funds are for steadfast and resolute investors. The index is not going to surge overnight. Itís a painful process that will take time, it could be weeks, but more likely months, before investors see some significant gains. A drop in the index should not disturb the investors, rather the intelligent investors should take this opportunity to increase their investments. But the bottomline is you will be smart enough to enter so low that your investment can only go up from here.

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