Should You Switch to Index Funds or Continue With Active Funds in the Present Market Environment?

Many people in India invest in actively managed equity funds to earn market-beating returns. The fund manager actively manages the equity mutual fund, and the research team picks the securities in line with the fund’s investment objectives. However, passive investing is rapidly rising in India, even as the passive fund’s assets surged 60% to a massive Rs 4.7 trillion in 2021. Moreover, AMFI data shows that many investors are moving towards index funds as folio numbers more than double from 8.1 lakh to 19.1 lakh over the past year. Should you switch to Index Funds or continue with Active Funds in the current market environment?

What are index funds?

Index funds are mutual funds whose portfolio mimics the composition and performance of a stock market index such as the BSE Sensex or the Nifty 50. It is a passively managed mutual fund that tracks the stock market index portfolio to give you matching returns.  

Moreover, index funds do not require the portfolio manager to churn the portfolio actively but hold stocks in exact proportion as the market index. It results in lower management costs than actively-managed mutual funds and thereby a lower expense ratio. 

Suppose you invest in an index fund that tracks the Nifty 50. If the Nifty 50 rises by 3% in one month, then the Net Asset Value (NAV) of the index fund that tracks the Nifty 50 will increase by roughly 3% over the same period. Conversely, if the Nifty 50 falls by 2% in one month, the Index Funds NAV falls similarly. 

Should you switch to index funds or continue with active funds in the present market environment?

You must invest in index funds in any market condition if you do not have the knowledge or the time to pick suitable active funds. Moreover, many first-time equity investors opt for passive funds such as index funds to get returns that match the stock market. 

Many investors choose active funds to get market-beating returns over time. However, 86% of large-cap equity funds underperformed their benchmark stock market indices from June 2020 to June 2021. It led to a rising interest among investors towards index funds where you can at least get returns in line with the stock market. 

You can invest in active funds if you are a market-savvy investor. However, it still pays to invest in index funds as part of your core portfolio. The core portfolio is about 70%-75% of your overall portfolio and stabilises your investment. 

You must build your portfolio to attain long term financial goals and ignore short term market movements. For instance, stock markets worldwide are highly volatile after the Russian invasion of Ukraine. However, it helps if you did not drastically alter your portfolio based on short term market conditions.

Based on market conditions, you don’t need to switch to index funds from active funds or vice versa. You must choose your requisite portfolio allocation to attain investment objectives based on your risk tolerance. However, you must monitor your investment portfolio regularly and rebalance it periodically. 

You don’t need to switch from active funds to index funds because of stock market conditions. It would help if you did not change your investment strategy because of short term market volatility. You can dedicate a part of your core portfolio towards index funds if it matches your risk profile. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in.

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