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Beyond Traditional Investments: Embracing Index Investing for Financial Freedom among Indians

Introduction


The world of investing can be intimidating, especially when confronted with numerous investment options and strategies. However, index investing, a popular strategy in recent years, provides a straightforward, cost-effective, and diverse approach to wealth accumulation. In this blog post, we will look at the origins of index investing, its benefits, and how Indians living in the UAE can benefit from this investment strategy by utilizing the region's various brokerage platforms. We will also discuss how traditional Indian investment options such as gold, real estate, and fixed deposits have consistently failed to outperform globally diversified index funds.



Meaning of Index Investing


Index investing is a financial investment strategy that entails building a portfolio of financial assets that replicates the composition and performance of a specific market index. Index investing seeks to achieve returns that closely resemble the performance of the underlying index while minimising the costs and risks associated with individual security selection and market timing.


Investors in index investing typically invest in index funds or exchange-traded funds (ETFs) that track a specific index. These funds invest in a diverse portfolio of assets, such as stocks, bonds, or other financial instruments, in the same proportions as the target index. As a result, the fund's performance closely tracks that of the index, effectively matching market returns.




Index funds may track a variety of market indices, including the S&P 500 Index (which represents the 500 largest publicly traded companies in the United States), the Nasdaq Composite Index (which includes all companies listed on the Nasdaq stock exchange), and the MSCI World Index (representing large and mid-cap companies across 23 developed markets countries).


Index investing is frequently associated with passive investing because fund managers do not actively select or trade securities based on their individual analysis or market forecasts. Instead, they simply follow the underlying index's composition, making adjustments only when the index itself changes (e.g., due to corporate actions, index reconstitution, or rebalancing).This passive approach results in lower management fees and transaction costs compared to actively managed funds, contributing to the long-term appeal of index investing.



The Roots of Index Investing and Its Pioneers


Index investing dates back to the 1970s, when John C. Bogle, founder of Vanguard Group, introduced the first index fund, the Vanguard 500 Index Fund. Bogle believed that rather than attempting to outperform the broad market indices through active stock selection and market timing, investors could achieve better returns by simply mirroring their performance.


Index investing has proven to be a successful strategy for many investors over the last 50 years. The vast majority of actively managed funds have consistently underperformed their benchmarks, whereas index funds have provided consistent and cost-effective returns. According to historical data, the S&P 500 Index has delivered an annualised return of approximately 10% over the last 50 years, showcasing the potential long-term benefits of investing in index funds.



Different types of investing: Active & Passive




Key message: As you can see, Active investment means, an active manager manages our portfolio and based on his technical and fundamental analysis picks and chooses stocks by buying and selling , this invariably increases the purchase costs for the investor and also have to shelve a lot of commissions in active investing. On the other passive investment does not involve any human effort, which helps the investor in keeping his costs low.


It’s a proven fact as history reveals active fund management has consistently underperformed the passive investing as indicated by SPIVA (S&P Indices versus active)


The SPIVA reports consistently demonstrate that a majority of actively managed funds underperform their benchmarks over the long term. Some key findings from the SPIVA U.S. Scorecard for the year 2020 include:




  • Over a one-year period, 60.3% of domestic equity funds, 71.9% of international equity funds, and 83.1% of emerging market equity funds underperformed their respective benchmarks.

  • Over a five-year period, 76.0% of domestic equity funds, 81.1% of international equity funds, and 88.0% of emerging market equity funds underperformed their respective benchmarks.

  • Over a 10-year period, 86.7% of domestic equity funds, 89.9% of international equity funds, and 87.8% of emerging market equity funds underperformed their respective benchmarks.



Portfolio Building : How to build a Portfolio of investing:


Building a portfolio for index investing involves several key steps. Here's a step-by-step guide to help you create an index investing portfolio:




Define your investment goals and time horizon:


Begin by clearly outlining your financial objectives, risk tolerance, and investment time horizon. These factors will play a significant role in determining the appropriate allocation of assets in your index investing portfolio. Ideally I would suggest to keep a timeline of a minimum of 5-10 years and in some cases forever.




Choose your asset allocation:


Diversify your investments across different asset classes such as stocks, bonds, and real estate to optimize risk and return. A common rule of thumb is to allocate a percentage of stocks equal to 100 minus your age, with the remaining balance allocated to bonds. However, this rule may be adjusted based on your risk tolerance, financial goals, and investment horizon.




Select the indices to track:


Choose the market indices that best represent the asset classes you wish to invest in. For example, we may choose S&P 500 as an index fund, similarly in India we can buy NIFTY 50 as an Index ETF, however according to John.C.Bogle’s philosophy the best investor holds the entire world market in the form of FTSE all world index fund ( this has a tracker symbol called VTI on the US stock exchange)




Choose the appropriate index funds or ETFs:


Identify the index funds or ETFs that track your chosen indices with the lowest expense ratios and highest tracking accuracy. When comparing funds, consider factors such as management fees, tracking error, liquidity, and the size of the fund.


Determine the fund allocation:


Allocate your investments across the chosen index funds or ETFs according to your asset allocation strategy. Ensure that your portfolio is well-diversified across various asset classes, sectors, and geographies to minimize risk and optimize returns.




Invest periodically and consistently: This is the most important mantra of all. Be consistent


Consider using a dollar-cost averaging (DCA) approach by investing a fixed amount of money at regular intervals, regardless of market conditions. This strategy helps mitigate the impact of market volatility and eliminates the need to time the market.




Rebalance your portfolio periodically:


Over time, your portfolio's asset allocation may drift from its target allocation due to fluctuations in asset prices. Regularly review and rebalance your portfolio (annually or semi-annually) by selling overweight assets and buying underweight assets to maintain your desired asset allocation.




Keep costs low:


Minimise trading costs and taxes by limiting the number of transactions I.e; no.of purchases per month.




Monitor your portfolio and adjust as needed:


Periodically review your investment goals, risk tolerance, and financial situation to ensure that your index investing portfolio remains aligned with your objectives. Make necessary adjustments to your asset allocation or investment strategy as your circumstances change.




By following these steps, you can build a well-diversified index investing portfolio that aligns with your financial goals and risk tolerance while minimizing costs and optimizing long-term returns.


Traditional Indian Investment Options and Their Limitations


Because of their perceived safety and familiarity, Indians have traditionally preferred investments in gold, real estate, and fixed deposits. However, when compared to the returns provided by globally diversified index funds, these investments have consistently underperformed.




Gold: Although considered a safe-haven asset, gold has delivered relatively modest long-term returns. Furthermore, gold investments do not generate income, have storage and insurance costs, and are subject to price fluctuations caused by global economic factors.




Real estate investments can generate rental income and potential capital appreciation, but they frequently require significant upfront capital, ongoing maintenance costs, and can be illiquid.


Furthermore, the performance of real estate investments is volatile and may not provide the same level of diversification as global index funds.




Fixed Deposits: Fixed deposits have historically been a popular choice among Indian investors seeking safety and predictable returns. However, the interest rates on fixed deposits have been on a declining trend, and the returns are often insufficient to beat inflation, resulting in a loss of purchasing power over time.






Why Choose Index Investing and Its Advantages for Indians Living in UAE




Lower Management Fees and Transaction Costs:


Index funds typically have lower management fees and transaction costs than actively managed funds because they require less trading and portfolio management.



Diversification:


Investing in a market index exposes you to a diverse set of securities, lowering the risk associated with individual stocks. Investing in globally diversified index funds boosts this diversification advantage even more.




Consistent Performance:


Index funds have outperformed actively managed funds, traditional Indian investments, and even market benchmarks over the long term, owing to their lower costs and the difficulty of consistently beating the market.




Simplicity:


Index investing is a low-maintenance approach to investing that is appealing to those with limited time or expertise in stock selection and analysis




• Since Indians don’t have to report or pay taxes back home when they are working and earning in UAE, it is beneficial for Indians to invest in American and global markets from here so that their investments are hedged against the US dollar, and in case any Indian wants to settle back home, at that time, they can withdraw their portfolio of earnings and convert them into India rupees during their retirement. So this will help their wealth hedged to the US dollar.




Brokerage Platforms Available in UAE for Index Investing


Several brokerage platforms in the UAE cater to investors interested in index investing. Here are three popular options:




Interactive Brokers (IBKR): Interactive Brokers is a global brokerage platform that provides low-cost access to a wide range of financial products, including index funds and exchange-traded funds (ETFs). IBKR is a popular choice for cost-conscious investors due to its competitive fees and robust trading platform. (www.ibkr.com)




Sarwa: Sarwa is a UAE-based robo-advisory platform that provides customized, low-cost investment portfolios primarily comprised of index funds. Sarwa's easy-to-use interface and personalized investment advice make it an appealing option for those new to investing or looking for a hands-off approach. (www.sarwa.co)




Swissquote: Swissquote is a leading online financial services provider that provides access to a diverse range of investment products, including index funds and exchange-traded funds (ETFs). Swiss quote caters to both novice and experienced investors, with a strong emphasis on providing advanced trading tools and research resources.(https://en.swissquote.com/)




In the end, Index investing through brokerage platforms such as Interactive Brokers, Sarwa, or Swiss quote can provide access to growth opportunities across various markets while minimising risk for Indians living in the UAE. You can make informed investment decisions that align with your financial goals and risk tolerance if you understand the origins of index investing, its benefits, and the limitations of traditional Indian investment options. Break free from traditional investment paradigms and embark on your path to financial success with the help of index investing. Congratulations on your investment!




In my next blog I will focus on how to invest in Indian markets and how not to miss the great Indian story in the making……thanks for reading and please do give your comments which will encourage me to improve the content.




References:


1) SPIVA® U.S. year-end 2022. (n.d.). S&P Dow Jones Indices. https://www.spglobal.com/spdji/en/spiva/article/spiva-us/


2) (n.d.). Sarwa | Investing Made Easy. https://www.sarwa.co/


3) Brokers, I. (n.d.). Home | Interactive Brokers LLC. https://ibkr.com


4) WBUR. (2012, December 12). Vanguard founder John Bogle: 'Stop looking for the next Apple — Buy widely and hold for life'. https://www.wbur.org/hereandnow/2012/12/12/vanguard-investment-bogle

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