10 Reasons to Invest in Index Funds

Why You Should Seriously Look At Index Investing

Over the last 2 years, there’s been a strong shift towards passive investing, especially through investing in index funds and ETFs. These funds mirror market indices without active stock picking. With the Sensex delivering 16.5% annualized CAGR over 43 years (excluding dividends), it’s clear why this strategy appeals. As many fund managers struggle to outperform the index, investing in index funds offers a smart, low-cost way to gain consistent market exposure.

Table of Contents

1. Why You Should Seriously Look At Index Investing
2. What are the advantages of index investing?

What are the advantages of index investing?

1. Index funds and Index ETFs are fantastic examples of passive investing. The portfolio mix of the index ETF reflects the index, which makes it simpler and more predictable.
    
2. As stated earlier, indices can be super performers over time. Between 1979 and 2022, BSE Sensex has given 16.5% CAGR returns, excluding dividends, which is another 1.5%.
    
3. The best thing is that index funds don’t have unsystematic risks. They only carry systematic risks. In short, the index is a naturally fully diversified portfolio.
    
4. Alpha is what every fund manager chases, but it has often been elusive; in India and globally. Index funds or Index ETFs do away with the concept of alpha. Hence investors are saved from negative surprises.
    
5. Index funds overcome human bias in a significant way. Most fund managers invariably let their personal biases come into their investment decisions. That is inevitable. In an index fund or index ETF, the only challenge is to track the index.
    
6. The biggest advantage of an index fund or an index ETF is low costs. A typical active equity fund may have a total expense ratio (TER) of 2.25% while the passive index ETF would have a TER of just about 0.4%. This compounds returns much better over time.
    
7. One argument is that many diversified equity funds are just a proxy for index funds. That is also a reason, why many of them don’t outperform. Then why pay 150-200 bps additional for such funds which eventually just about reflect an index portfolio?
    
8. In India, the percentage of active funds that manage to beat the index is sharply reducing. If you look at recent reports, just about 10-12% of the funds beat the indices on a consistent basis. India is moving towards the US model, so a greater shift to passive funds is likely to get accentuated in India.
    
9. Like the global markets, Indian markets are also getting more efficient and spreads are getting tighter. Going ahead, fund managers will substantially struggle to beat the index on a consistent basis. That is where passive funds and index funds fit in.
    
10. In active investing, it is very difficult to distinguish between the skill of the fund manager and market support. That is where index funds and index ETFs just remove the bias from investing altogether.