The bellwether Indian broad market index, the 30-stock Sensex, had its 40th birthday on 1 April. Actually launched on 2 January 1986, the base date was 1979, or that is the day when the value of the index was 100. Forty years later, the value of the index is near 39,000. A simple average annual return calculation says that the index return is around 16%. But the real return is much higher. The managing director and chief executive officer of the Bombay Stock Exchange, Ashishkumar Chauhan, tweeted: “If we take dividends in to account, on total return basis, it would be close to 56,000." In other words, ₹1 lakh invested on 1 April 1979 is worth ₹5.6 crore today. A similar amount invested in a fixed deposit, gold or the Public Provident Fund (PPF) would have given far lower returns.
But what is the index and how is index investing a good strategy for an average retail investor? A stock market index is the average price of the companies that the index chooses to include. Think of an index as a barometer that shows the change in the price of something we are trying to measure. We understand a price index—when inflation goes up, it is the price index that has gone up. An index can measure anything—prices, wages, happiness and stock market prices. The most representative parts of the space that the index hopes to measure get counted. For example, the consumer price index will comprise of prices that are relevant to a consumer—food, fuel, clothing and housing. Similar in a stock market index, the most representative companies that are listed on a stock exchange get included in a broad market index like the Sensex. The ups and downs in prices will cancel each other out, but if the price rises on an average have been more than the price falls, then the Sensex will go up and vice-versa.
A low-cost and safe way for retail investors to get an equity exposure is to buy an index fund or an exchange-traded fund on a board market index like the Sensex or the Nifty. You will always be holding the most representative firms of a market. Remember that the composition of the Sensex has totally changed from 1979 to today. Steel, cement and other commodities were a large part of the index then, now newer sectors like telecom, financial services and information technology have entered. When you hold an index fund, you don’t need to sell or buy stocks, as the index changes its composition, the index fund managers sell and buy the same stocks in the same proportion as the index. What is called the “fund manager risk", or the risk of your fund manager making wrong calls, is not there in this strategy. You can buy an index fund on other cuts of the market—mid-cap, small-cap or some specific sectors.
But who holds for 40 years, you wonder? Well, we do hold our real estate investments for decades and then compare the entry value with the exit value, don’t count the costs and feel really happy. The right way to compare would be to look at the average annual return number. Unless you were very lucky with your real estate investment, a broad market index return in India would have done better. The other reason index investing is far superior to buying a piece of real estate is that when investing in an index, you don’t need to know anybody, or have inside information on when a piece of agricultural land is going to go commercial, or predict the change in a political party’s fortune to make a killing, as you do in real estate deals. You don’t need a tonne of black money, like you do in real estate. You don’t have to go around looking to sell a loo, or a bedroom, when you need liquidity, you just sell some part of your very liquid investment. Buying real estate exposes you to the same risk as buying a specific stock with far clunkier processes. Buying the index takes that risk away.
But won’t this market steam get exhausted—how much further can it go? No, the Sensex may be 40 years old but is far from being in a middle-age slump. The mistake we make is that we look at the absolute value of the index and say, it is at 40,000 or 50,000—how high can it go? The correct way is to look at what is the growth potential of the economy and how well firms are poised to make profits. If India continues to grow at 7-8% for the next 20 years, the long-term value of a broad market index will reflect this growth. So if you think you missed the great Indian equity ride, belt up, there is plenty of ride left in this journey.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation
