Should You Invest In Index Funds Like Warren Buffett?

index funds
invest in index funds

Should you invest in Index funds like Warren Buffett?. Mutual fund investors have risen rapidly from last 5 years with the knowledge of the fact that now it is a necessity, to secure their future by investing in different investment options.

Now we have options for child plans for our child, retirement funds for our retirement,Liquid funds for contingency, we have wide options with a different category of funds

But somehow, the idea of index funds has remained unnoticed by most investors in India.

Warren Buffett in one interview said that investors can make good returns by investing in index funds, which are passive funds. Citing the example of Vanguard index funds that track the S&P 500 index of large American companies. Buffett said that passive or unmanaged funds can do better or give good returns than hyperactive or actively managed funds which are handled by fund managers who charge hefty fees to manage it.

Does this Theory of making good returns from passively managed funds hold good in the Indian market context too? Can we follow the same principle or philosophy of Buffett?

This guru mantra might work for investors in the US or any other developed market, but may not be that effective in India, at least at the current stage of evolution of the Indian equity market 

“Buffett’s quote is relevant in the US context, where a majority of funds underperform the benchmark index. It is not relevant in the Indian context, where the majority of funds outperform the equity benchmark,” 

The big difference is that USA equity market is matured enough or most equities in indices are available to investors. But India still more of an emerging equity market, where new companies still are being discovered or yet to be listed or become part of the index.

In the Indian market, any fund manager provides a lot of alpha over the index. In case of actively traded large-cap funds, the returns could be higher than the index by 200-300 basis points over a five-year period. While in case of mid-cap funds the returns could be even higher. That is why over the long-term actively adjusted funds will give better returns,’’ as per equity analyst says.


So, what is an INDEX Funds?

As the name suggests, it is a fund that invests in an Index. In other words, it performs in the same tandem as Index performs. It replicates the index in the same weightage or in the same proportion as we can see in the Index.

Warren Buffett Quote is an undeniable truth that cost is an important part of a return for an Investment, if your cost is high then your return will get diluted to that extent, Index fund charge very low fee as compared to actively managed funds.

Cost of any funds is an important aspect to consider while making any investment, in actively managed fund Management fee may go up to 2.5%-3%. But in Index fund usually, we need to give 0.2% to 1%.

For example, In SBI Nifty Index fund has an expense ratio of 0.27%(in Direct Plan) whereas, in same fund House SBI BLUECHIP has an expense ratio of 1.13%.Same, In UTI Nifty Index funds, have an expense ratio of 0.13%.

The Biggest advantage of index funds is the low cost. The expense ratio of most index funds is less than 1%, and another advantage is the Low volatility. While Active funds can give you more return or can generate 3-5% alpha over the funds, but in the downturn, it could fall by the same margin, Index funds are suitable for those investors who want to avoid volatility in their investments.

Another Factor to consider while making an investment in Index funds is Tracking error, which is nothing but the difference between the returns of the index fund and the benchmark index. 

Tracking error happens when the fund is unable to match the index movements. Say, there’s an open-end fund that tracks Nifty and it goes up by 90 basis points, while Nifty itself goes up by 1%. The difference would result in tracking error. You should always prefer to those funds which have low tracking errors in their past performance.

I know investors in India will hardly change the perception for index funds, don’t know whether this trend will change or not but keeping all the data in mind, it is hard to invest all of your money in passive index funds currently.

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