Index funds – a good place to be in uncertain times

this article appeared in reuters india’s  personal financial page….

If my students do not ask “When will the market touch 21000 again?”, I ask them the same question.

The most optimistic answer I have got is 6 months and the most pessimistic answer I have got is 2 years. Very clearly short term memory is very strong and erases all long term memory! So I translate the question a little and ask “How long does it take your portfolio to recover after a bear market?”

The best answer, as always is “I do not know”. However, the ego of the sales guy and fear of the customer ensures that an answer “palatable on that day” is “6 months”. Luckily you can say the same thing for 3 years, and nobody will blame you (or remember).

I have tried to see what happened in the past (with the caveat that the past is not an indicator of the future, as always). The Sensex was 574 in March, 1986. After that it reached 713 in Mar, 89. Similarly the sensex was 4285 in March, 92 and convincingly crossed it in March, ’00 when it closed at 5001. However if you had entered the market in March ’00 then it was in Mar ’04 when it reached 5590. Assuming you had invested in March, 2008 when the index was 15644 when will it cross 15644. This is your question, is it not?

So let us see – 3 years, 9 years, 4 years, ….you do not want to believe it, do you? So it might be a while before we say a definitive number.

But there’s a way to avoid this entire “catch up” worry: Buy an index fund. I call it “peace of mind” investing. The best performer in my wife’s portfolio is Hdfc Prudence fund over the past 5 years.

And that investment continues to do well – the fall is cushioned by the fact that there is an element of debt in that fund – about 30-35%. Though I do not know whether that is a good strategy for the long run, I am taking that call!

I am taking a wild, guess. However, I feel if you index 70% of your equity portfolio in a large number of stocks (like CNX S&P 500) by doing a SIP you are likely to outperform many of the fund managers. As I said earlier market calls are fund manager jobs, not column writers’. But I will take that chance. Benchmark mutual fund is launching a fund which answers to this description.

Is there a downside in such a fund? Yes given the liquidity in the indexed stocks (all 500 are not liquid enough) there will be a high tracking error. And unless the fund house collects a lot of money, the asset management charges will not come down – the current charges are quite high for an index fund.

Like any equity product, it pays to do your research. An index’s history and longevity are some of the best benchmarks you can use.

Countless investors have been sacrificing returns for safety. But with indexed funds, it’s a decision that they should be easy to make.

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