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Starting your first investment no longer requires much thought or action. It’s literally a job done in 30 mins. Nevertheless, where you invest today makes a big impact on your future investment choices too.
The choice is huge – you could go with bank fixed deposits, unit-linked insurance, crypto, trading stocks, mutual funds, public provident fund, a piece of the startup pie and so on. Contrary to what some say, this choice also needs to be simple and effective. It is the experience which will make or break your faith in long-term investing, in growth assets and in displaying patience over decades. It is also the experience which will underline your cost of investment and hence, the search for simple and effective.
Passive equity funds fit in very easily to this mould of simple and effective and work wonderfully if you as the choice for your very first long-term investment.
What is a passive equity fund?
A fund of any kind typically pools money from several investors and invests across multiple securities or investment options. A mutual fund is structured under a license from the market regulator, to pool small amounts from many investors and invest in equity stocks, bonds or even in gold, among other securities. This investment is unitized and owned by investors. A passive mutual fund is one where the portfolio of securities is linked to a market index rather than being selected by a fund manager.
What this means is, the portfolio you invest in will mirror exactly, the number and type of securities in a chosen index. A passive equity fund for example, which is linked to the Nifty 50, will have all the 50 shares in the Nifty 50 in the same proportion as the index itself has. There are several types of passive funds and not just in equity but made of bonds too.
The advantages of passive funds are many.
- There is no security selection risk which otherwise would be left up to the fund manager and you would have to rely on their competence for gains.
- The cost of investing in a passive fund is the lowest among all types of mutual funds.
- It is liquid, which means you can invest and redeem at any point in time.
- Passive funds in the index fund avatar allow you to start a systematic investment plan (SIP), wherein you can invest in small lots regularly every month or week.
- They do not have a defined maturity, you can invest today and hold on for 10-20-30 years, thereby really milking the compounding impact.
Passive funds come in two wrappers, exchange-traded funds (ETF) and index funds. ETFs are listed on stock exchanges and you can buy and sell these just like you would any other stock, through your broker. Index funds on the other hand are under the mutual fund umbrella and you don’t need a broking or a demat account to buy and sell these. The latter is also useful if you want to start systematic investments or withdrawals.
You cannot start an SIP in an ETF if your broker does not allow it.
Why passive funds work to begin with
In other words, a passive equity fund is a low-cost, simple way to begin your long-term investment journey. You can compound returns over the next few decades and benefit in the life stage when you are closer to the peak of your lifestyle expenses. These are flexible, you can redeem your money if you are in need at the redemption comes at no cost. You may redeem partially or completely, depending on your requirement. You can switch schemes too if you feel it necessary. Or else you can remain invested for as long as you want to.
The money is invested in a composition that mirrors a popular benchmark index, which means the stocks in your portfolio are the more liquid and large-sized companies which reflect the state of the economy too via growth and earnings.
Equity investments benefit the most if you remain invested for long periods because you are investing in companies or businesses which will also take time to grow and deliver earnings growth. Some may be established businesses with stable market share, nevertheless. Growing the earnings of a company takes years and hence, investing in stocks of companies is an activity of patience and if you focus on quality, positive results get delivered over time.
Investing in any kind of a fund ensures you are diversifying your equity investments, such that if some of the companies don’t do well in the future your entire investment is not at stake. Historically, the benchmark equity index has not given a negative return for any ten-year period over the last 20 years. At least 75% of the time, returns beat annual inflation by 2%-3% on a post-tax basis. Inflation represents price rise and it is what eats up the value of money consistently, hence, any investment you make must beat average annual inflation so that the value of your money is actually growing.
How should you choose the right one?
There is no right or wrong passive fund. It depends on the kind of exposure you want.
There are plain vanilla passive funds which simply mirror a popular existing index and then there are smart beta passive funds which apply filters or conditions on the existing index and then invest in the stocks that come clean through those filters.
Starting out with a simple, single-index passive fund is step one. There are several of these, almost all large and mid-sized asset managers offer passive funds mirroring the Nifty 50 and Sensex 30. Ideally, pick one where the assets under management are reasonably large and the annual expense ratio is low.
Also, check the reported tracking error which shows the divergence in return from the actual index return and that could be on account of cash holding or other expenses in the fund.
The table below shows the variety of large-cap index funds with some of the metrics important for selection.
Large-cap diversified passive funds with at least five years of return experience
Index funds are a simple low-cost way to earn inflation-beating returns in
the long term
| Funds | 5 Yr Ret (%) | 10 Yr Ret (%) | Expense Ratio (%) | Net Assets (Cr) |
|---|---|---|---|---|
| Aditya Birla Sun Life Nifty 50 Index Fund – Direct Plan | 11.41 | 12.16 | 0.32 | 529 |
| Bandhan Nifty 50 Index Fund – Direct Plan | 11.94 | 12.88 | 0.11 | 65 |
| DSP Nifty 50 Equal Weight Index Fund – Direct Plan | 10.66 | — | 0.39 | 500 |
| Franklin India NSE Nifty 50 Index – Direct Plan | 11.39 | 12.38 | 0.24 | 485 |
| HDFC Index Fund Nifty 50 Plan – Direct Plan | 11.70 | 12.82 | 0.20 | 7,825 |
| HDFC Index Fund – S&P BSE Sensex Plan – Direct Plan | 12.51 | 13.20 | 0.24 | 485 |
| ICICI Prudential Nifty 50 Index Fund – Direct Plan | 11.71 | 12.82 | 0.34 | 22 |
| ICICI Prudential Nifty Next 50 Index Fund – Direct Plan | 5.21 | 13.19 | 0.30 | 2,477 |
| ICICI Prudential S&P BSE Sensex Index Fund – Direct Plan | 12.49 | — | 0.16 | 896 |
| IDBI Nifty 50 Index Fund – Direct Plan | 11.58 | 12.40 | 0.32 | 190 |
| IDBI Nifty Next 50 Index Fund – Direct Plan | 5.37 | 13.07 | 0.32 | 50 |
| Nippon India Index Fund – Nifty 50 Plan – Direct Plan | 11.70 | 12.60 | 0.20 | 710 |
| Nippon India Index Fund – S&P BSE Sensex Plan – Direct Plan | 12.53 | 12.82 | 0.15 | 401 |
| SBI Nifty Index Fund – Direct Plan | 11.58 | 12.43 | 0.18 | 3,595 |
| Tata Nifty 50 Index Fund – Direct Plan | 11.79 | 12.56 | 0.16 | 386 |
| Tata S&P BSE Sensex Index Fund – Direct Plan | 12.46 | 12.82 | 0.27 | 215 |
| Taurus Nifty 50 Index Fund – Direct Plan | 11.54 | 12.63 | 0.44 | 2 |
| UTI Nifty 50 Index Fund – Direct Plan | 11.79 | 12.76 | 0.20 | 9,965 |
What next?
Once you have chosen a fund, figure out whether you will be able to invest regularly at a predefined frequency like a month or so. If the answer is yes, set up a SIP for the amount you can invest each month. For the sake of spreading risk, you can pick two schemes, mirroring two different indices. However, stick to simple, diversified indices for the moment rather than specific themes and beta portfolios.
All you need to do is open an account with an online broker who also offers transactions in mutual funds and set up your monthly SIP. There is no headache of stock or fund manager selection, no trading costs, no large tax bills and no need for frequent monitoring.
Voila! Your very first investment is done.
What are you waiting for – get started now!
If you like what you have read or have any feedback to give, don’t forget to leave your remark in the comments section.
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