Is it the right time to invest in index?

Coronavirus pandemic have shaken the world not just in terms of the number of infections and death toll but also, financially. The stock markets globally have nosedived and are expected to fall further. In India, S&P BSE Sensex fell nearly 39.35 per cent from its all-time high of 42,273.87 in January 2020 to the levels of 25,000 by the end of March 2020. Nevertheless, in the past two to three weeks, we saw some recovery in the market. Sensex is now trading above its psychological level of 30,000. However, even with this recovery, Sensex is still down by around 27 per cent.

Now the question arises whether or not, you should consider investing in index funds or ETFs. Surely, without any second thought, you should go ahead and invest in these. It will benefit you when the markets start recovering. Large-cap indices like S&P BSE Sensex, S&P BSE 100, Nifty 50 and Nifty 100 would start recovering first. Therefore, it makes a lot of sense to accumulate the units of index funds or ETFs at these lower levels. However, while doing so, you should consider systematic investment plan (SIP) mode of investing. If in case you have a lump sum to invest then, invest in a staggered manner and not all at once.

Why invest in index funds now?

In order to deliver alpha, actively managed funds might be overweight on certain stocks, as compared to indices. Even though actively managed equity funds are diversified to stock specific risks, there are chances that the fund manager’s calls go wrong due to the complexity in the current economic situation. This might lead to its underperformance with respect to index. To avoid such risks, you can simply invest in large-cap index funds.

Also, in such crises-like situations, investors’ sentiments drive the markets rather than its fundamentals. S&P BSE Sensex and Nifty 50 are those two indices that reflect the sentiments of the investors. Therefore, when the sentiments become positive then, these two indices would first start moving towards a positive trajectory.

How to select index funds?

There are only two things to remember before investing in index funds.

1. Tracking error

2. Expense ratio

Ensure that both the tracking error as well as expense ratio are low. Invest in those funds, which are not excessively outperforming or underperforming the index. This is because excessive outperformance or underperformance defies the purpose of index investing and acts like active fund management. Besides, you can use lower expense ratio as a tool to increase your returns from index funds rather than its performance.