Index Investing: A sure way to win in the stock market
Stock Market, It’s an ocean which may build fortune like Buffett and can destroy big castle of money within seconds. In the Market, there are people using their knowledge and skills to make money, few are trying to mimic great investor’s success stories and rest are trying their luck. Here, for every winner, there will be a loser. I am writing this article for the people who are beginners in the market or planning to be in the market. In this article, I will be talking about investing strategy with which you can make big money with time without losing your hard earned money. To use this investing strategy you don’t have to be an MBA from a top business school or you don’t have to be math genius either. I am talking about Index Investing.
If you are already in the market you must be having the idea about index investing, if you are new to the market and never heard about Index investing, don’t worry this article will explain you everything about it. Few facts about the market, Nobody knows where the market will go tomorrow or a day after, people can speculate (guess) it and they do that quite often but in facts, nobody knows where it will go. But looking at the history we know one thing about a market, In the long run, it has the tendency to go up. These two facts about the market look very trivial but this information has the potential to make you a millionaire. In the rest of the article, I will be explaining to you how to use this information to build a fortune in the market and what is index investing.
To understand Index Funds, the beginners in the market should know what is index. The index is a hypothetical portfolio which contains top companies of that market or sector. In each market, there will be multiple indexes representing different sectors and different asset classes of companies. Taking the example of Indian stock market we have Nifty50 tracking top 50 companies listed in NSE and Sensex tracking top 30 companies listed in BSE. There are other indexes as will such as Nifty midcap 100 index which tracks top 100 mid-cap companies in NSE and we have sectoral indexes such as BankNifty, Nifty Metal, Nifty IT and many more, these indexes represent top companies of their sector.
Before investing in an individual company financial institution or investors with higher-net-worth investigate each fact about that company such as their balance sheet, management, future prospects of a company and many more things, which is not an easy task if you are not a professional investor. On the other hand, we are aware of the fact that in long run markets (Indexes) have the tendency to go up, so in place of investing in individual companies, beginners can directly invest in Indexes. Let me surprise you with the fact, in the long run, 90% of fund manages fails to match the return of Index funds. Let me share some historical facts to justify my argument.
On 1'st Jan 1999 Nifty index was around 890 points and today (Dec 20, 2018) after approximately 20 years Index reached 10,951 points. In these 20 years, Nifty 50 index gave more than 1200 % returns which is more than 12 times of invested money. So 1,00,000 INR invested in Nifty index fund would have become 12,00,000 INR. This growth rate is 13.4% compound annually, which is good enough return with minimal risk. You can notice 2008’s market crash looks like the small downfall for a short time which did not impact much to overall return.
As we have verified the returns of index funds and understood the benefit of it, now let’s talk about another very important factor which makes stock market awesome, that is compounding (compound interest) of wealth. Let’s witness the magic of compounding and how it impacts our investment with time. Here is the graph of Sensex from 1966,
Since 1987 to 2018, Sensex index returned around 78 times of invested money, which is 14.1 % compound return annually. If we compare it from Nifty50 annual return which is 13.4% annually then there is a difference of 0.7% annually. Now let’s see how much impact this extra 0.7% is doing to our returns. If we assume a consistent return of 13.4% from Nifty and keep our money invested for 32 years then we will get a return approx 56 times. In the same timeframe of 32 years, 14.4% compounding is returning 78 times of invested money and 13.4% compounding is returning 56 times of money, the difference of 22 times of money is caused by tiny 0.7% difference in return. This is the magic of compound interest. A small amount of money getting the benefit of compounding (even very small rate) will grow to a huge amount of money if enough time will be given.
So here is the index investing strategy in nutshell, buy index based funds when the index goes down suddenly and hold it long enough so that compounding does its job well.
How to invest in Index
There are multiple ways to invest in any index. In every market there will be some mutual funds based on different indexes of that market, you can buy these mutual funds and that’s it. While buying mutual fund try to buy direct mutual funds, if you buy mutual funds through agents your returns will be less up to 1% compared to same mutual fund bought directly. So the easiest way to invest in an index fund is to buy a direct mutual fund of that index, another way is finding out all shares of the desired index and buy them according to their weight in the index. Each share will have different weight in the index(e.g. weight of RELIANCE in Nifty is 8.96% as of Dec 21, 2018), you decide how much amount you want to invest in index and buy index shares according to their index weight. This method is little tedious for small investors but to big investors, it gives more freedom as they can choose the weight of each share according to their knowledge and experience. To retail investors, I will suggest going with index-based mutual funds.
How long should I stay invested
Once somebody asked Warren Buffett that what is your favourite duration for being invested in a company, ‘Lifetime’ he replied. Duration of being invested is very subjective it depends on so many factors such as investor’s age, cash flow sources and their investment objective. In my opinion, if you are around 35 or less, then start doing SIP in index Funds and let your money be there for next 15 to 20 years or more, the market will surely reward you. If you are older, still no worries, being invested in an index for 10 years may give you returns up to 3 to 4 times of your money.
What if market Falls
Well, it always happens, that is part of the game. If you are an index investor, the market falls are great opportunities for you to buy more. Do not panic, and do not sell off your funds in the falling market, just wait, the market will recover. The market fall is not the time of selling your holdings, this is the time of buying more in discounted prices. One thing always keep in mind, nobody knows the bottom of a falling market, so don’t invest when the market is going down, wait for a trend reversal, start investing when the market starts going upwards.
This is my opinion about Index Investing If you liked it then give me a few claps, share this article with your investment buddies and for more articles subscribe to my publication.
Jai Hind!
Disclaimer
This article shoes my opinion about index investing, it is not intended to be an investing suggestion or recommendation. Please reach out your investment advisor before investing.
