How Long Can We Invest In Index Funds?
The notion of investing in index mutual funds in India has long piqued the interest of investors—large and small alike. In many ways, index funds have the potential to be a great option for a long-term investor. By investing in index funds rather than individual stocks, an investor is able to spread their money across a variety of different companies’ stocks or bonds and be less affected by the day-to-day functioning of any one company. Additionally, index funds India also tend to charge relatively low fees and some may even pay dividends back to the investor.
When it comes to investing in index mutual funds in India, how long one should do so, the answer is not as straightforward. There is much debate as to how long is too long and how often investors should shift their investment opportunities.
Traditional Approach:
When investors choose to invest in index funds over a long period of time, which could mean five years, ten years, or even a lifetime. This is the traditional approach to investing in index funds and many analysts claim it is a great way to create wealth for retirement.
Investors such as David Swensen, author of the book Unconventional Success, promote diversifying an investor’s portfolio over long-term investments, as well as re-balancing the portfolio no more often than every five to ten years. This way an investor can reduce the risk of owning a single stock or bond and keep their portfolio composition broadly diversified no matter what the current stock or bond market conditions are. The idea is to invest in index funds India then hold onto those investments for a while, allowing the fund’s holdings to pick up stream, increasing the investor’s returns.
Short Term Approach:
Some investors may choose to invest in index funds for a short time frame of less than a year or 2 years, this is more of a short-term approach. Many new investors prefer short-term investments as it offers lower risk as opposed to long-term ones. Short-term investments can also be beneficial for investors looking to access quick returns on their investments.
The key is to invest in top index funds with lower expense ratios and to stay away from those with higher fees as these can cut into potential returns. Additionally, investors should consider the time-frame they are comfortable investing with when making their investment decisions.
Return Expectations:
Your risk and returns co-relate to one another. Hence, long term investing gives a better opportunity for earning higher returns.
An investor with a higher risk appetite and willing to invest for a longer time that is greater than 5 years, can expect to earn approximately 5 to 15% returns on an annualized basis by investing in index funds.
Whereas, an investor with lower risk appetite and investing for a shorter time frame of less than 5 years, may earn between -1.03% to 15% returns on an annualized basis.
Since the short term volatility determines how much you can make in less than 5 years, returns may be negative as well. The chances of earning a negative return is almost negligible for a long term investor as the volatility is adjusted in stock prices over a longer time frame.
Exit Plan:
Returns earned through investing must be materialized through a well-planned exit strategy and regular rebalancing.
You can plan an exit for short term investments on achieving returns that are 2X or 3X your risk appetite. For example, if you buy a mutual fund unit at a cost of Rs.100 and have a 10% risk appetite. You should either exit from your investment at Rs.90 if the investment goes wrong, or exit at Rs. 120 (2X your risk) or Rs. 130 (3X your risk).
Exit plans for long term investments are planned based on your financial goals and regular rebalancing. You may rebalance your portfolio’s asset allocation after every fixed period of time. For example: An investor planning to invest for 10 years for a certain goal starts with a 60% equity and 40% debt mutual fund portfolio mix. He can, in every 2 years, rebalance the portfolio by reducing the equity schemes and increasing the debt ones, until the last 2 years of his goal tenure with only the debt schemes remaining to exit.
Tips to rebalance the mutual fund schemes in your portfolio:
- Redeem the mutual fund schemes that no longer align with your financial goals.
- Remove mutual fund schemes that have overlapping investments in the same assets.
- Keep the number of mutual fund schemes in your Portfolio as per your diversification needs, financial goals, tenure of goals and risk appetite.
- Avoid holding the losing investments in hope of recovery for too long. Similarly, avoid booking your profits too soon on the winning investments.
Read more: Optimizing the number of mutual fund schemes in your portfolios: how to do it?
Conclusion:
No matter the length of time one chooses to invest in index funds, there are some general rules of thumb that all investors should follow. For example, investors should strive to diversify their portfolio, be aware of fees, and monitor the investments regularly. This means knowing when the markets are doing well and underperforming and being prepared to make decisions accordingly. Additionally, investors should focus on their financial objectives and goals in order to make well-informed decisions about how long to invest in index funds and how best to manage the portfolio.
