Where Should I Invest In The Stock Market, Do You Have Any Tips?

If you are an investor, beginner or experienced, I have a pretty simple test based on which I can make recommendations. 

Ask yourself, “am I Warren Buffet (or Rakesh Jhunjhunwala)?” If the answer to the question is ‘no’ then I would recommend investing in the Index. If it is ‘yes’, then please leave a comment, I am a big fan!! 

Hmm….ok, so you made your point, but what is the Index? 

A market index is a hypothetical portfolio of investment holdings that represents a segment of the financial market.

The index is nothing but a few stocks taken together and their performance tracked into a single number. 

In India the two main indices we discuss are the Sensex and the Nifty. 

The Sensex is made up of the 30 biggest stocks traded on the Bombay Stock Exchange and the Nifty is made up of the 50 largest stocks on the National Stock Exchange. 

The definition of Nifty 50 and other indices on NSE India can be found here, including some of their rules for what makes a stock eligible. 

What is important for us to know, is that these two indices Nifty and Sensex represent the health of the stock market. 

So, 50 stocks represent the entire market? 

Well, yes, you might have heard Sensex and Nifty being discussed in various news reports. When someone says the market has tanked or risen, they are usually referring to these two indices. 

But if you want a broader basket, there is also the Nifty Next 50, these are the next 50 largest stocks on the NSE. 

But why should I invest in these 50 stocks and not pick out the best stocks myself? 

Picking the right stock to invest requires a lot of skill, effort and experience. 

If you have the ability, then most definitely you should pick your own stocks. However, the Nifty 50 is made up of 50 stocks that represent the most successful companies in India as of now. 

Buying the Index is like spreading your investment over the top companies in the stock market.  

“Don’t look for the needle in the haystack. Just buy the haystack!” 

John C. Bogle

You said ‘as of now’, does that mean the companies in the index change?

I am glad you picked that up. Yes, the companies that make up the Index keep changing, there is a half yearly process where the Index updates the companies in the list.

If you compare Nifty 50 from 2013 to the Nifty 50 today, there are only 32 companies that are still part of the index. 

The Nifty 50 was at 5,852 points in June 2013 and today, July 2021, it is at 15,722. 

So, if you had invested in any of those ill-fated 18 companies in 2013, chances are that you would have fared poorly. Investing in the index instead would have given 20%+ annual growth over this period. 

There is a lot written about investing in the entire index rather than picking out stocks, John Bogle, popularly known as the father of index investing started the Vanguard Fund with an aim to provide low-cost index investing. Today Vanguard manages more than 7 trillion dollars of investments. 

So, should I not pick a mutual fund with an active fund manager who will beat the index?

Over the past few years, most large-cap funds have struggled to beat the index. A key difference between index and actively managed funds is the fees. The active funds have to pay for the staff they use for research and decision making, the index fund just uses an algorithm. 

SBI Nifty 50 fund, direct plan, has an expense ratio of 0.17% and the SBI Blue chip Fund direct plan has an expense ratio of 0.97%. 

So, to beat the index, the mutual fund manager has to deliver you returns which are better than the index plus the additional fees. 

To illustrate that, over the last 5 years the SBI Nifty 50 fund has delivered a return of 14.35%. To match that performance the SBI bluechip fund would have had to deliver:

14.35% + fee difference (0.97% – 0.17% = 0.80%) = 15.15%.

In reality it has delivered a return of 13.72%.

A more important point with choosing the right fund is, you don’t know which one is going to out-perform the market.

Here is an article I found about the top large-cap funds in 2012/13. Well, I don’t recognize any of them. UTI changed to Axis and SBI magnum probably morphed into SBI Bluechip, most of the others are not in the top few now. Past performance is actually no indicator of future returns, as the mutual funds’ advertisements proclaim. 

I will just switch to the best performing fund regularly ?

For one, you only know which was the best performing fund last year, not the best performing fund for the next year. Then, there is the cost of switching funds. There might be transaction costs charged by your broking platform. There is definitely going to be tax implications every time you sell. In the long run, consistently getting market returns will be better than occasionally getting higher returns.

“Owning the stock market over the long term is a winner’s game, but attempting to beat the market is a loser’s game.” 

John C. Bogle

Ok, you have convinced me, about the index. How do I invest in one ?

There are two ways. You can invest in a Index fund, similar to buying units in a mutual fund. You can invest via a platform such as ET Money or any other. 

Alternatively, you can buy an Index ETF (Exchange-Traded Fund). An Index ETF is a mutual fund converted into stock. It is listed on the market and you can buy it like you buy any stock. I buy mine on Zerodha. ETFs have lower expense ratios than funds. 

My preference is to invest in low-cost ETFs whenever possible. Also, you can buy at the price you see, unlike a fund that calculates the NAV at the end of the day. Marginal difference I am sure, but it is my preference. 

What about taxes? 

Index funds and ETFs are taxed similar to equities, short term is less than a year and taxed at 15% and long term at 10%. 

What if I want to invest in a particular sector of the economy, like banking? 

Well, so far we discussed the broad-based index, there are also sectoral indices. If you are keen on benefitting from the gains in banking stocks then the Nifty Bank Index is available. 

While there are a few sectoral indices in India, we are still far behind when compared to a more index heavy market like the US, which has 1700+ indexes. 

However, keep your eyes open, there are new index funds being launched regularly. One fund that I am watching with interest is the momentum index. 

You can also invest in the US stock markets through Indian funds. Motilal Oswal has two funds the S&P 500 and the Nasdaq100 funds. Of these, the Nasdaq 100 is also an ETF.

Finally, why have I not heard about this before? 

For one, index investing in India is picking up steam in the last few years. To quote this article from the week – “According to data from Association of Mutual Funds of India, net assets under management of index funds stood at Rs 15,359 crore at the end of January, almost double the Rs 7,944 crore AUM at the end of January 2020.” 

The other important reason is the fees. Index funds typically charge low fees. Therefore, index funds won’t make it to a list of recommendations, where the advisors operate on a commission basis. Do read this article on financial advisors.

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The key takeaways:

• Picking individual stocks takes specialized skill and lots of effort. You have a low probability of picking a winner 
• Investing in an Index gives the benefit of the entire market’s performance 
• The Index changes periodically, you get the benefit of sticking with companies that are doing well
• Actively managed funds will find it hard to beat the index regularly especially considering the higher fees they charge
• It is very hard to predict which fund will consistently outperform the market.
• ETFs are index funds that are traded like stocks and easier to buy and sell on any platform
• You can invest in a particular sector using a sectoral index such as Bank Nifty

So, if you are an investor like me, who has a day job and cannot spend hours evaluating where to invest, I would recommend looking at an Index ETF. It is the best thing for a passive investor. 

I will let Warren Buffet have the last word on this. Here is a passage from one of his letters to shareholders. If it is good enough for Warren it is good enough for me. 

“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) 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.” 

Warren Buffet

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.