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Why Most Indian Investors Are Not Yet Cut Out To Be Successful Indexers

Writer's picture: Akshay NayakAkshay Nayak

An increasing number of Indian investors are gaining awareness of index investing. This trend has especially picked up since the COVID-19 crisis in 2020. But right now most Indians who prefer indexing prefer it for the wrong reasons. They adopt the strategy without a holistic understanding. This means that they will not be able to experience true success as index investors. There are a number of reasons for this. And today's post will talk about these reasons in detail.


Comparing Performance For Evaluation


Some investors compare the performance of two or more index funds tracking the same index to evaluate the fund. Doing this makes absolutely no sense. Index funds simply mirror the portfolio and performance of the benchmark index that they track. So there is going to be no major difference between the returns of two index funds that track the same index. Therefore comparing performance between index funds only creates confusion and lowers conviction.


Believing Factor Funds Are Index Funds


Factor funds or smart beta funds are a special category of mutual funds. They combine the best qualities of actively managed mutual funds and passive index funds. This sees them being perceived by investors as a passive alternative that offers better returns than the market. But such perceptions are illogical.

The essence of genuine passive investing lies in holding all the securities within an index. They are to be held in the proportion in which they appear within the index. A factor index is a subset of a broad market index. A factor fund holds a set of curated stocks that all share certain quantifiable characteristics. The stocks are selected in accordance with preset rules. This means that there is a degree of active management inherent to factor funds. Therefore they cannot be considered to be similar to passive index funds.


FOMO And The 'Little Bit Of Everything' Syndrome


Most investors may look to hold every category of index funds available in their portfolios. They may wish to hold a large cap index fund, mid cap index fund, small cap index fund and factor funds. This is mainly attributable to FOMO (Fear Of Missing Out) and an obsession with maximising returns. This unnecessarily clutters the portfolio and increases portfolio costs.


The very aim of index investing is to keep portfolios simple and costs low. Cluttering the portfolio with multiple index funds defeats both these essential purposes of index investing. The essential objective when managing our finances should be to achieve our goals. Not to maximise our returns. Realising this is the key to beating FOMO. Some other ways in which FOMO can be managed are set out in the graphic below.

A single Nifty 500 index fund would give us adequate exposure to large caps, mid caps and small caps. But right now we only have a few viable Nifty 500 index funds in India. This allows greater room for expense ratios of Nifty 500 index funds to be manipulated. Therefore the most viable category of index funds right now would be Nifty 50 index funds. Those who wish take a slightly higher degree of risk can combine Nifty 50 and Nifty Next 50 index funds. Nifty Next 50 index funds are an ideal proxy for mid and small cap exposure in the portfolio. And long term returns from these funds are enough to give us a reasonable chance of achieving our goals. So there is no need to go beyond them when building our portfolios.


Implicit Faith In Index Investing Is Yet To Be Demonstrated


Most Indian investors currently see index investing as an easy way to earn returns from equity. This is especially true for those who entered the markets post the COVID crash of 2020. By coincidence markets have largely enjoyed a strong run post the COVID crash. This is why index funds have also done well. But this won't always be the case. Like any other strategy, index investing too will go through prolonged periods of underperformance.


It remains to be seen how committed today's investors remain to index investing when this happens. Implicit faith in a strategy is what defines our success with it. And it can only be gained when a strategy is understood holistically. Most Indian investors lack a holistic understanding of index investing. Therefore it is highly unlikely that they will develop implicit faith in index investing. It is therefore equally unlikely that they will be successful at it


Final Thoughts


It takes two things to fully appreciate the benefits of index investing. They are a reasonable amount of maturity and an innate preference for simplicity. Most Indian investors currently lack both of these. The most important benefits of index funds are not the returns or that they beat most actively managed funds. It is the simplicity and clarity that index funds bring to our portfolios and investment approach. Most Indian investors simply don't understand this fact. And as long as the case remains such, it would be hard to say that Indian investors are well placed to be successful indexers.


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Disclaimer : The information given in all articles on my blog Finance Made Fun For Everyone is meant for educational purposes only. None of the information given in any of these articles must be construed as investment advice. Readers are advised to act on information they find in this blog at their own discretion after adequate due diligence. 

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