Maximize Your Returns with Minimal Effort: The Game-Changing Benefits of Index Funds for Busy Professionals

Financial

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Mir Amir Sohel

6/27/20234 min read

Introduction

If you're a busy job holder or someone who lacks the time to learn about investing but still wants better returns , you've come to the right place. In today's blog post, I will explore the best way to invest your money to achieve higher returns than a fixed deposit without taking on extra risk.

So, what exactly is an index fund?

An index fund is a type of mutual fund or exchange-traded fund (ETF) that tracks the performance of a market index. It follows a passive investment strategy and typically has lower expenses and fees compared to actively managed funds. Index funds can also serve as a "reluctant regulator," influencing the suitability of companies for an index¹.

A market index is a collection of securities that represent a particular segment of the market. For example, the Sensex index consists of 30 large-cap Indian companies that cover a significant portion of the Indian share market. Different indexes exist for various markets, such as bonds, commodities, currencies, and international stocks.

An index fund invests in the same securities as the underlying index to replicate its performance. For instance, an index fund tracking the Sensex would invest in the same 30 companies that make up the index. The fund would adjust its holdings whenever the index changes its composition.

Why is an index fund a better option for most investors, especially those with limited time or interest in learning about investing? Here are some reasons:

1. Low cost: ETFs generally have lower fees than actively managed funds because they don't require expenses for research, analysis, trading, or marketing. The average expense ratio for an index fund is around 1%, while it's around 2.5% for an active fund. This means that choosing an index fund can save you Rs 1,500 for every Rs 1,00,000 invested per year compared to an active fund. And if you think a 1.5% difference doesn't matter, let me clarify. Let's assume you have Rs 2,00,000 to invest for 20 years, and you have two options: an actively managed mutual fund with a 3% charge or an ETF with a 1% charge per annum. If both the mutual fund and ETF generate the same 12% return, after 20 years, you would have approximately Rs 16,12,462.00 if you invested in ETFs and Rs 11,20,882.00 if you invested in the mutual fund. The difference, caused by just a 2% variance in the long run, becomes substantial.

2. Tax efficiency: ETFs generate less taxable income than actively managed funds because they have lower turnover rates. This reduces the capital gains taxes you would have to pay when selling your shares. ETFs can also benefit from tax-loss harvesting, which involves selling securities at a loss to offset gains from other investments.

3. Diversification: ETFs provide exposure to a wide range of securities within a single fund, reducing overall risk. By investing in different ETFs that track various indexes, you can build a portfolio that aligns with your desired asset allocation. For example, you could allocate 60% of your funds to stock ETFs and 40% to bond ETFs.

4. Performance: Over the long term, ETFs tend to outperform actively managed funds due to their lower costs and avoidance of human errors. While there are a few exceptional active fund managers who can outperform ETFs after accounting for fees and taxes, they are rare, and identifying them requires judgment and skill. If you can assess their expertise, you may consider investing in them.

5. Simplicity: ETFs are easy to understand and invest in. You don't need to research individual stocks or bonds, time the market, or select the right fund manager. Instead, you only need to choose an index fund that matches your risk tolerance and investment horizon and stick with it for the long term.

What Does Warren Buffett Think About ETFs?

Warren Buffett, one of the most successful investors of all time, is a strong advocate for ETFs for the majority of people. He has repeatedly recommended low-cost S&P 500 ETFs as a safe and intelligent way to grow your money over time.

In his 2013 letter to Berkshire Hathaway shareholders, he wrote:"My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund (I suggest Vanguard's). I believe the trust's long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions, or individuals – who employ high-fee managers."Buffett even won a bet against five hedge funds by investing in the Vanguard Index Fund, which served as a proxy for the S&P 500. The bet lasted from 2008 to 2017, and Buffett's index fund returned 7.1% annually, while the hedge funds only returned 2.2%.Buffett's primary reasoning for investing in ETFs, particularly the S&P 500 index fund, is that they match the market's performance over time and have low management expenses. He also believes that investing in a broad basket of stocks is a bet on American business, which he expects to do well in the long run.

Conclusion

For most individuals, ETFs are an excellent way to invest in the stock market. They offer low costs, tax efficiency, diversification, performance, and simplicity. Moreover, they are endorsed by one of the greatest investors of all time, Warren Buffett.

If you're looking for a straightforward and effective approach to grow your wealth over time, consider investing in ETFs. You can start by opening a brokerage account or a retirement account and selecting an index fund that aligns with your goals and risk profile. Remember, the key to successful investing is to start early, invest regularly, and maintain a long-term perspective. As Buffett said, "The stock market is a device for transferring money from the impatient to the patient."

Disclaimer: I am not a registered financial advisor with SEBI or any regulatory authority. The information provided on this website/blog is for educational and informational purposes only. It should not be considered as financial advice or a recommendation to make any investment decisions. Before making any investment, it is crucial to consult with a qualified financial advisor who can assess your specific financial situation and provide personalized guidance. Remember, investing involves risks, and past performance is not indicative of future results. The content on this website/blog should not be solely relied upon for making financial decisions. Always conduct thorough research and seek professional advice before investing. The responsibility for any investment decisions rests solely with the individual reader.

Maximize Your Returns with Minimal Effort: The Game-Changing Benefits of Index Funds for Busy Professionals