I meet a lot of potential investors during these minars and education programmes that I conduct. Very few of them do not want to invest. But they are all worried about the time and energy it takes to keep track of the market and of course they are wary of the risks. For such millennials who are looking for a safe mode to park their funds and are patient, passive investing can come in handy.
First let me explain what passive investing is. A passive fund mimics the growth of an index say Sensex or Nifty and replicatesits returns to the investors. For example, if one invests in a five year oldNifty50 fund, the returns of the fund and that of index will be the same. And,indices seldom fail.
We have two types of passive funds – ETFs or exchange traded funds and Index Funds.
In India, passive funds make for a measly 5% of the total money invested, while in the US, it is at around 50%. Here are five reasons why millennials should consider them:
1. They’re simple and easy to understand
After the 2008 crisis, investors have realized that there is much they do not know about the complicated products that are sold to them — like credit default swaps. Hence, they should and must invest in products they can understand. Passive funds are as simple as they can get.They invest in an index and the fund will choose stocks that will provide the same collective returns as the index. It can be Midcap50 or Nifty50 or Nifty100so on and so forth.
2. It will not ‘cost’ you
Yet another brilliant advantage of a passive fund is that it is chosen by an algorithm. As the Scheme is not actively managed but is passively managed hence the costs are low. On the contrary, active investing would require continuous research and constant churning of the portfolio, and there are fees associated with it – at around 1%.
If an investor goes for a 15 year time frame,the 1% fees gets heavy. It would compound over time and could be as high as half the portfolio. For long-term investments, the lower the cost the better as it would determine the quality of returns. With passive funds, an AMC only charges the expense ratio. Also, most AMCs like us, are going in for more and more automation and any savings in this regard will be ploughed back to the investor.
3. You can manage risks better
After every Mutual Fund ad, the disclaimer says- mutual funds are subjected to market risks. In truth, a typical fund is subjected to both fund manager risk and market risk. In a passive fund, it is pure market risk as a fund manager’s stressed decisions will never affect them.The fund will keep picking stocks that are best performers in the underlying index.
They are much safer since passive funds can ride the downturns well especially if invested for the long term. We have observed that markets correct every seven to ten years. Irrespective of corrections, an index always grows over most comparable periods and investors will receive the returns.
Even for active investors who deal directly in the markets, investing a part of their portfolio in passive funds helps. These funds are more about managing risk better and bringing in discipline rather than returns. Over time however if the investors let the magic of compounding work, they do deliver.
4. The bad apples can be weeded out
Since passive funds invest in the best performers of a market, it is possible that troubled stocks and some such might be automatically added. This is the question that most people have about passive funds. But let me put such doubts to rest. The indices weed such stocks out as they under perform and slip down. When this happens, the fund too automatically pulls them down so the average returns over time stays the same.It is like this – one stock crashing won’t affect the index for too long.Passive funds are similar.
Also, the effect of one stock over 200 others gets cancelled out in most cases. Passive funds are capable of absorbing these shocks.
5. Best among equals
Most active investors long for a diverse portfolio which passive funds can offer by default. In earlier days, Nifty50 was full of industrial companies, infrastructure, oil and gas and utilities.Today around 35% of it belongs to financial services. So it automatically picks the best performing stocks and no matter what happens to a certain sector,passive funds provide an opportunity to have the best of the best in the kitty.
Disclaimer:
Views and opinions contained herein are for information purposes only and should not be construed as investment advice/recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully
