How to start investing in Index Funds in India?

Currently, there are around 468 passive funds or Index Funds available in India. In such a situation, how to start investing in Index Funds in India?

As there is a huge attraction towards Index funds from mutual funds investors, obviously this question is common. However, before jumping into answering this question, one must do certain preparation. Do remember that currently there are around 468 Index Funds (including ETFs) available in India. Choosing 2-3 among these is obviously a daunting task for all investors. The probability of swaying with the trend and investing in the wrong index may be high.

How to start investing in Index Funds in India?

Before answering this question of “how to start investing in Index Funds in India”, as I mentioned above, you have to do below homework.

# Define financial goals

Before blindly trying to invest, first, identify your financial goals. Goals may be like your kid’s education, kid’s marriage, or retirement goals. However, if you are unable to identify the goals, then at least you must have clarity of how long you are going to hold this investment (irrespective of market conditions). If you can’t identify your financial goals or are unable to visualize the time horizon of your holding period, then no matter whichever asset or product you choose, its RISKY. Hence, having clarity about this first step is most important.

# Asset allocation

The next step is to identify the asset allocation between debt to equity based on the time horizon of the goal and your risk appetite. Never rely on recent past data to judge that the same fantastic journey will continue in the future. Do remember that equity is not meant for the goals which are around the corner like within 3-5 years. Also, having higher equity exposure beyond your risk-taking ability may devastate your financial life. Never invest more than 75% of your money into equity (no matter how long the goal is). Hence, allocating properly between equity and debt is the next important step. Never invest all your money in equity (refer to my earlier post “Is It Wise for Young Long-Term Investors to Put 100% in Equity?“.)

# Be realistic in returns expectation

Expecting equity returns based on recent past returns may devastate your overall financial life. Hence, be realistic from the equity portfolio. Expecting more than 10% to 12% is a high risk. Hence, be cautious of what to expect. It is common to have unrealistic expectations during the bull run. But look into the past data and try to understand the risk and volatility.

# Index Funds does not mean SAFE or for BEGINNERS

Many think that Index Funds are safe. Sadly this the the completely wrong belief. By choosing the index funds you are just removing the risk of the fund manager. But it does not mean Index Funds are risk-free. You have to face the market risk. The risk of Index Funds varies based on what type of Index Fund you are choosing. But it does not mean risk-free.

Never choose Index Funds just because of cost. Instead, you must have a PASSIVE mindset before investing in Index Funds. No matter whatever time period you choose, certain active funds may be outperforming passive funds. However, it does not mean that they will outperform the index in the future too. Hence, rather than just looking at Index Funds’ cost, you must have a proper passive mindset.

One more myth many preach is passive funds are for beginners. It is wrong. Passive funds are for those who are experienced in handling their mindset and don’t want to churn the portfolio regularly. Hence, to be frank, passive funds are for experienced investors.

Also, Index Funds do not mean high returns. It means simplicity, and peace of mind and you are indirectly reducing the exercise of changing the funds often.

# How many Index Funds are enough?

As I mentioned above, currently there are around 468 passive funds available. It does not mean you need all of them. But obviously financial industry creates such an atmosphere that all these 468 funds are NEED for you. But the truth is all these 468 funds are needed for mutual fund companies but not for you. Hence, don’t choose more than 2-3 Index Funds for your overall equity portfolio.

In fact two Index Funds like Nifty 50 or Nifty Next 50 are enough. However, if you wish to have exposure to mid-cap (along with Nifty Next 50 which actually acts like mid-cap in terms of volatility and returns), then you can choose Nifty Midcap 150 Index. Beyond these adding funds is unnecessary and useless activity. Avoid so-called factor-based funds or momentum funds as I mentioned above, they are for mutual fund companies but not for you.

Finally, keep your portfolio so simple that you can easily explain your strategy to your small kid. Complicating your portfolio does not mean high returns.

Conclusion – Beware!! You just need 2-3 funds for your portfolio. The remaining 465 funds among 468 available passive funds are NEED for mutual fund companies but not for you!!