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Is this the best time to invest in Index Funds?

Equity market has faced the biggest crash in the last decade due to fast spread of coronavirus and subsequent lockdown.

Big crashes have hit the stock market every few years. However, each crash has typically been followed by a vigorous recovery and rally for 3-5 years.

So while many investors are sitting at losses, this could be an opportunity to invest. But to invest in equity you have to identify good stocks and sectors.

Index funds could be a good option at this point of time. These are funds that typically invest in companies which are part of an index of best companies from a particular theme or sector.

“Index funds are the least risky funds. But it will be subject to market ups and downs,” says Harsh Jain Co-founder and COO Groww.

Right time to invest

Buying cheap is the mantra for any successful investment. Investors who have bought cheap are bound to benefit more when market recovers. “Markets have corrected a lot. The price earning (PE) ratio which was trading at more than 30 is now trading at 20.5. Last month it had touched 17.57, but substantially corrected. Same way dividend yield of Nifty 50 right now is 1.67% (April 9, 2020), which is very attractive considering the historical yield of as low as 0.9%,” says Nitin Shahi, Executive Director of FINDOC.

Further correction in the equity market cannot be ruled out. “Saying that the markets have corrected, one cannot confirm that the markets have bottomed out. In the recent past only the Nifty was trading at 7,500 (the PE Ratio was 17.57 and dividend yield was around 2.0) which is now trading at 9000+,” says Shahi. However, most of the experts agree that major correction has already taken place and even if there is a further correction it is unlikely to be as big as before.

Saves risk of picking wrong stocks

When market have gone through a crash and the dust is yet to settle, many investors will have concerns whether it is right time to go for fresh investment. “Many stocks are trading at very attractive valuations. For a retail/layman investor it will be very difficult to identify these stocks. But since the market has corrected substantially, one can invest through index funds,” says Shahi of FINDOC. This

Even if you are willing to invest through actively managed mutual fund schemes, the chances of an index fund giving better return will be higher. “Under the current environment, markets are complex and volatile. It will be challenging for funds to showcase performance. This is the opportune time to consider alternatives such as index funds,” says Rahul Jain, Head, Edelweiss Wealth Management.

Should you invest lump-sum or go for SIP?

If you have investible surplus, a lump-sum investment at one go may not be a good idea. “I would suggest that investors should invest up to 30% of his/her desired portfolio at current levels and either wait for deeper correction or use SIP mode for remaining 70% of the corpus,” says Shahi.

You may also follow staggered investment if you just want to invest lump-sum. You may start with investing at least 30% at current level. If the market corrects by 10% more, you can invest 40% and if it corrects by 20% you can invest the remaining 30%. However, if you do not see any further downside in next 2-3 months you may invest a part and wait for another quarter to invest the rest.

Which index fund should you invest in?

Even in index fund you have many options which range from market capitalisation based indexes to sectoral indexes. “Right now FMCG, pharma and IT indices are in demand but I would recommend only diversified funds as these indices and stocks of the indices mentioned above are trading at 52-week high prices. It would be better to invest in diversified funds like Nifty, Sensex or Nifty Next 50 funds. When the markets recover we can see creation of wealth by investing in these index funds,” says Shahi.

Rahul Jain of Edelweiss also supports this view. “Globally, investors have access to a variety of funds that mirror various indexes available. However, in India, it is advisable for investors to invest in index funds based on the Sensex and the Nifty,” he says.

Same index fund is offered by many fund houses, forcing investors to make a choice. “An investor has to carefully consider the expense ratios of such funds and tracking error in percentage terms. In addition to the limited universe of stocks available which impact performance of the fund,” says Jain. Tracking error is deviation of return of the index fund from the index due to various technical and operational issues. You should go for the fund which has the lowest tracking error.