Can index funds create retirement corpus?
Index funds are those mutual funds that invest primarily in index stocks. They buy all the stocks in the index that it is tracking in the same proportion. This means that the index funds perform in line with the index that it is tracking with minor difference known as tracking error.
Though fund managers manage funds actively with an intention to beat the benchmark index by way of active stock picking. There are certain studies done globally which show that it is not possible for a fund to beat its benchmark index year-after-year. On the contrary, index funds passively track the underlying benchmark index. These funds are not meant to outperform the benchmark index rather try to be in-line with it.
So the question is whether index funds can help you save for your retirement. Let us take an example to understand it better. Assume your current living expense is Rs. 30,000 per month and your age is 40 years and the rate of inflation being 7 per cent as well as post-retirement and you are planning to retire when you turn 60 years old. So when you turn 60, you would require monthly expenses of Rs. 1.16 lakhs per month and assuming you will live till 85 years and expected rate of return post-retirement to be 9 per cent, you would require Rs. 2.79 crore to maintain your current standard of living post-retirement. So if we look at the average returns provided by the index funds then they have given average returns of 0.74 per cent in one year, 15.65 per cent in 3 years and 12.88 per cent in 5 years. The retirement being 20 years away, let us assume that you would get approximately 13 per cent CAGR (Compounded Annual Growth Rate) for the next 20 years. So if we consider that you would require to do SIP (Systematic Investment Plan) of around Rs. 27,000 per month until you turn 60 or you may also do a lumpsum of Rs. 24.21 lakh.
Before investing in index mutual funds or in any mutual funds for that matter it is important to assess your risk. However, an index fund can prove to be one of the good options for conservative investors who are not comfortable in investing much in equities. Although this won’t be suitable for those who are aggressive risk takers as this would give a low to moderate return over a period of time.