Money is indeed one commodity that you must take into account seriously. Otherwise you will one day wake up not having any single cent that you wish to spend with all your needs most especially in times of urgent and crucial situations. There are various ways to invest or make your money earn passively. The most basic and proven are the index fund and the diversified fund. It is one reality in finance that had you put your money in the S&P CNX Nifty Index 5 years ago, there is a 70% chance that you would have made more money than by investing in a large-cap fund. According to S&P CRISIL SPIVA report for the year ended December 2009, over 70% of large-cap funds underperformed the S&P CNX Nifty Index over a 5-year period. This is a lot of money that you should have earned from investing in the said manner mentioned above.
Because of such turn of events discussed above, there is now a sudden change of status with regard to Sensex. But at the same time, with the Sensex reaching near-18,000 level, market experts are calling it a stock picker’s market rather than one for the index investor. So, what should you, as an equity investor, do? Is it time to invest money into an index fund or stick to a diversified equity fund? To know the way forward, you need to answer some of the following three questions.
Obviously, the most basic response given in view of this question can make your life simple. Investors prefer to choose between active or passive styles of investing depending on their needs. It has been observed in developed markets that institutional investors such as pension funds looking for asset exposure prefer to stick to passive investing by opting for index investments. Hence it is important to be more keen in view of investing your hard earned money.
Truly, these policy holders and investors are willing to commit their money for a long term. Liquidity remains a key parameter in any investment decision of these investors, which is ably addressed by index investing. The second segment of investors that would like to opt for index investing is known as ‘asset allocators’. It must be noted here that once done with their risk profiling and investment needs, they prefer to allocate their money to various asset classes and hold on to them for a long period resorting to asset re-balancing at regular intervals. Index funds are preferred vehicles for many asset allocators.
Moreover the rest of the policy and plan holders, typically looking for alpha — the excess returns over the returns offered by the broad market — can look at actively-managed funds. These are the common type of people who simply wish to invest their money in a company who will do something with regards to earning from their capital.
In must be noted moreover that, while investing in the market, there is a need to have a sound foundation of a theory you subscribe to. Efficient market hypothesis (EMH) is a celebrated and equally-criticized theory in markets. EMH maintains that the financial markets are information-efficient. Hence, the prices of traded assets already reflect all the available information and keep changing to accommodate any new information. In other words, stocks always trade at a fair value and factor in all possible information available in the market. Hence, no investor can buy an under-valued stock or sell an over-valued stock. There is no scope for an investor to beat the market in the long run by earning excessive returns than those offered by the broad market.
It is obvious a fact that as an investor you therefore must be wise and smart in view of which type of investment will you risk your hard earned money. If you believe in this theory, indexing is the best solution to look at while investing. Market returns can be earned at low cost with minimum efforts at your end using an index fund. Yet, if you are looking at Warren Buffet as the reality and believe in the possibility of beating the markets hands down in the long term, it’s better to look at actively-managed diversified equity fund. A point to note, the possibility of beating the market is one thing and an investor doing so in reality is another.
Hence as a person who wish to double your capital, or at least to earn, you should note down your strengths and weaknesses. When you look at a mutual fund to invest, either you have admitted that you cannot invest in equities on your own or you prefer to have a ‘money manager diversification’ that should help if your equity investments do not deliver. Ask yourself this question then, have you been investing in under performing schemes only? Have you been investing in schemes you know because those are advertised the most? Saying ‘yes’ to these questions brings forth some bitter facts. Be it the lack of time or lack of willingness, desire and ability to analyze a fund scheme, you run the risk of investing in a wrong scheme. If this is something very clear to you, then there is a greater chance of earning big bucks.
Furthermore, value research says that, in the diversified equity funds category that delivered an average return of 29.28% over one year as on July 29, 2010, the best fund delivered 59.99% whereas the worst booked 6.98% returns over one year. With the high range and the popular caveat — past performance is no guarantee of future — your choice of fund manager matters. If you want to avoid this gamble, look at indexing.
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As a conclusion, it is good to quote some experts in view of their respective opinions and stand on which among these two types of fund is more effective and proven successful in terms of earning more income from your capital or investment: “After deciding on asset allocation, based on risk profile, investors should invest in low-cost solutions such as index funds that offer them exposures to desired asset classes,” says Sanjiv Shah, executive director, Benchmark AMC. Most critics say index fund managers do not book profits at higher levels. “If investors stick to their asset allocation and book profits using asset re balancing, index funds investors can take their profits home,” points out Mr Shah. Hence, after hearing from their side the last card has been finally opened and laid down for you to finally decide on which type of mutual fund suits you best.
