Why is My Portfolio So Sad, While the Market is Booming?

I hear laments from friends that although the market has gone up 10-20-30%, my portfolio is languishing and its performance is nowhere close to even what the Index has reported.

In a portfolio comprising of stocks, it is normal to gloat about one or two outperforming ones which may have doubled or tripled and focus on those to feel good about how we picked out the winners.

But in their hearts, investors know that the duds in the portfolios more than makeup for the winners and net effect may not be boast-worthy.

It is not easy for investors of actively managed mutual funds too, there are few schemes that consistently outperform. A typical investor wants to buy and forget about it. It is not practical to move in and out of mutual funds as there are costs involved in terms of exit load and there can be tax impact.

There is an easy way to ensure that your portfolio gives you returns which is exactly the same as the benchmark indices or what is called the “market”.

Let’s just understand what exactly an index is.

The Stock market is made up of many many stocks. A business or company gets listed or is said to be in the market when they access the public for capital for their business.

In India, there are more than 6800+ listed stocks. These companies have taken money from the public and subsequently, the investors or traders are buying and selling the stock or the ownership in those companies.

Out of 6800 + listed stocks, actively traded are close to 2000.

There are all types of companies that are traded and listed. Some are A-listers very large companies and some are micro-companies and some are nonstarters.

On a given day, multiple trades are getting executed, some stocks are going up, some are going down.

Imagine a playground full of children running around. Hard to gauge what’s happening.Need some sort of game with rules and order to manage the chaos.

An Index is created to make sense of the direction and moves in the market. An Index represents stock prices of a diversified group of companies which gives you an indication of the move of the market. Different indexes represent different things but the most widely used ones are BSE Sensex & Nifty 50 which is what we will discuss here.

BSE SENSEX – Bombay Stock Exchange Sensitive Index represents the 30 largest companies traded in the market representing various industrial sectors of the economy. 

Nifty 50 – It’s owned by the National Stock Exchange and represents the 50 largest companies in India.

So the Sensex and Nifty represent the movement and direction of the prices. There is a methodology via which weights are assigned and which companies make the cut to be a part of the indices.

Coming back to our portfolio.

From the March 2020 bottom, Nifty 50 has rallied about 40%. That is if you had invested in the bottom, the portfolio would have risen by 40%.

The last 1year CAGR or compounded return of the Nifty 50 would have been just broken even or no return, last 3 years 5% and 5 years 7 %.

Investors who are wanting to replicate these returns have a very easy way of doing it. Via Index funds or passive Index Exchange-traded funds or ETF’s.

Passive Index funds or index tracking ETF’s invest exactly in stocks exactly in the same proportion as the Index. That is the reason that if you invest in them you will get a return close to the Indices they track.

What is the difference between Index funds & Exchange Traded Funds?

Index funds work like mutual funds and are primarily bought and sold from an Asset Management Company which is also called a Mutual fund. If you want to buy an index fund you have to buy from a mutual fund and when you sell you instruct the mutual fund and they pay you the proceeds.

Exchange-Traded funds are also created by the Asset Management Companies but are primarily sold on the stock exchanges. They are traded like normal stocks. Sometimes ETf’s trade at a price higher or lower than the intrinsic value of the portfolio (the NAV) depending on the number of buyers and sellers.

ETF’s are very popular worldwide and are gaining popularity here in India as well. In India, they have an AUM of about 2.07 lakh crores and have garnered most of this in the last five years.

You can read about ETF’s Here.

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What exactly is the advantage of buying an index fund or a passive ETF?

If you buy say an HDFC Index fund – Nifty 50 plan today. Or you invest in an ICICI Prudential Nifty ETF. Say, you invest for three years, and in that time the Nifty 50 returns an 8% CAGR.

Your return will also be close to 8% CAGR. It may be slightly lower due to something called tracking error or expense ratio but it should be a minor difference.

What is a tracking error?

Typically there are some costs that are involved in buying and selling securities and some amount of expenses which are incurred by the fund house. So the return may be slightly lower than the underlying benchmark.

Are there other types of ETFs?    

Yes. In developed markets, there are ETFs that track anything and everything J.ETF’s tracking tech companies,  biotech, particular geography, a particular segment like millennials spending, or tracking stuff like gold, real estate, mining companies, energy, leveraged companies.

There is an oddball ETF that tracks live-stock prices and also a WFH (Work from home) ETF.

A passive ETF is one that mimics an index exactly. There are many indices and there are separate ETFs tracking them. For eg Kotak Banking ETF tracks the Bank Nifty.

The Bank Nifty in turn is an index comprising of banking stocks. If you track it you will know the direction and the extent of movement of the banking sector in the economy.

In India, there are ETF’s tracking Midcap indices, Infrastructure, Gold, Bonds, Central Public sector Units, etc.

You can find a list Here.

What should one keep in mind while investing in Index funds & ETF’s?

1. Compare and check the expense ratio & the tracking error.

2. For ETF’s one needs to check the liquidity. Some ETF’s don’t have enough buyers and sellers and are considered illiquid. 

To circumvent that the fund houses have launched Fund of funds (FOF’s) which invests in the ETF. When the investor wants to sell, they put in redemption and the fund house will honour it. There is no need for the investor to look for a seller or a buyer on the stock exchange.

This is a simple no brainer way to invest. It is not glamorous nor will it give earth-shattering returns.

You will be pleasantly surprised though, how much wealth can be created by boring compounder products.