Investing in Sensex: Good Decision or Bad?
Is the much acclaimed Bombay Stock Exchange.s 30 stock Sensex(Sensitive Index) which is also the indicator of the Indian Stock Exchange Market, good enough to invest in? You bet, the Sensex can be a zero risk investment if you have it in you to hold on to it, for a minimum of 13 years. If you buy Sensex, it would imply that you are holding on to the shares of thirty companies that are represented in the same way as the index. Experts state that you can earn closed to 23 to 34 percent per year between 12 and 15 years without even worrying about the risk that is a reflection of trading in stock exchange.
Time diversification is the phrase given to the notion that stocks are not so risky in the long term as compared to the short; and if you hold the market index for long enough, you can decrease risk to almost nothing. In short, timing in the market is not so important as time in the market.
If you look at just one year spectrum, the risk of investing in Sensex is 322 percent. However, if you stretch it long term, the risk falls. Over five years, the risk factor comes down to 64 percent and in 25 years, the risk is just 3 percent. In short, you will get average, consistent returns if you invest in the index and stay invested for a long time.
Holding an index for a long period of time ensures that you are getting the best out of winning companies. The losers actually get kicked out of index. Over the past 20 years or so, 37 companies have had to leave the index. The index is smart enough to show sunshine sector companies like Bharti Televentures, which is now popularly known as Airtel; this company was included in the index on November 10, 2003. If you had bought Sensex for Rs. 10 lakh on that date, you would have made Rs.16 lakh today. Airtel has actually grown seven times its value since its inclusion in the index.
An index fund was the industry standard for those who were into index investing. It came into existence through the efforts of the founder and former CEO of the Vanguard Group, US, John Bogle. The index investing became very popular in the US market and took the problems of stock marketing in the US away. They had low costs compared to managed funds and gave decent returns. Then came the exchange traded funds, which were traded on a stock exchange similar to a stock, but they were very much like index funds as they tracked the index and imitated its returns. The cost of these funds were low, just 10 paise per Rs. 100.
As of now, India has 17 index funds and 5 exchange traded funds; this is less compared to most developed markets. However, we should consider that India is still a developing country and the economy is still to mature. You can measure the effectiveness of a financial investment as against an index with the help of an indicator called .alpha. The alpha of diversified equity funds in India is 0.3 for the past 3 years. This implies that diversified equity funds have gone ahead of index by 30 percent in the last three years, if you take an average. But at the same time, you should consider how well Index investment can be, because there is zero risk involved compared to diversified equity funds.
Ideally, the zero risk formula to long term growth is that you should opt for broad marked index Exchange Trade Funds over index funds. The index funds in India do have tracking errors and the costs are higher than ETFs which are just 40 to 60 paise annually on Rs. 100. So if you have a portfolio of Rs. 10 lakh, it can cost you Rs. 4000 in an ETF, Rs. 13,000 in an index fund and Rs. 40,000 in a diversified equity fund annually.