The benefits of passive investing usually come into the limelight in falling markets.
From the beginning of the year to the middle of May, Nifty 50 was down by 8%, whereas half the Nifty 500 stocks were down 10-30%, and a further fifth were down >30%.
A portfolio would naturally have exposure to stocks from Nifty 500, and not just Nifty 50. The state of portfolios would be much worse compared to the mainline index. And here’s when investors realise and appreciate the benefits of passive investing.
What is passive investing?
Passive investing is when you buy an index and not take the effort to consciously allocate your money over different sectors or in different stocks. Passive investing can be achieved through index funds.
An index fund is a type of mutual fund or exchange-traded fund (ETF) that holds all (or a representative sample) of the securities in a specific index, with the goal of matching the performance of that benchmark as closely as possible.
For example, the Nifty 50 in an index. If you were to build a portfolio of all the 50 stocks in the proportion that they are in the index, you would need a few lakh rupees, and you would need to constantly change the proportion as it changes in index. This would turn out to be a tedious and expensive affair.
To make this easier, you can invest using Mutual Funds or ETFs which simply follow or replicate the movement of the indices.
Why invest passively?
Passive investing has several benefits over active management:
Over the long run, in several countries, passive funds on average have beaten fund managers. Fund managers aren’t usually able to consistently beat the index over long durations.
Index funds cost as little as 0.5% (or lower) per annum of the amount invested. This turns to be pretty cheap compared to the up to 2.5% fees you would pay for active management.
Passive investing offers optimum diversification through tracking an index. Actively managed portfolio may lead to under or over diversification, or suboptimal sector allocation and/or stock selection.
With a bunch of different funds, one can build a robust multi-asset portfolio, which is often difficult to build using individual securities.
Options in passive investing
There are multiple indices available to choose from, which also cut across different asset classes. With index funds or ETFs you can take exposure to equity, government debt, corporate debt, gold, international equities.
Within asset classes several options are available. For example, in equities you can choose according to market cap (large, mid or small), or even choose a sectoral index (like auto, pharma or IT), or even choose value stocks or momentum stocks.
These choices are available in other asset classes too. In debt, you can choose maturity (1 day, 5 year, 10 year, etc.), or even between government debt and corporate debt, or even take exposure according to the credit rating.
How to invest
It is easier to invest in the top index funds in India more than ever – with paperless documentation and a hassle-free procedure.
Index funds can be bought from the AMC’s website, any mutual fund distributor app, or even from one of the broking apps.
For buying ETFs, all you need to have is a demat account. You can then buy these from your broking account.
Building a portfolio
With so much choice available, it is often difficult to decide which funds or ETFs to buy and how to build a portfolio. According to us, any passive portfolio should have the following characteristics:
It should have a mix of various asset classes
The portfolio needs to match the investors risk profile
Asset class selection needs to be relevant to current market trends
Security selection needs care when investing in India because of low liquidity and potentially high price risk
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