How to become a successful Index Investor?

Success in investing is doing two things: Investing early and investing long. Albert Einstein said - “Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

To give an example - 1 lakh invested at a 12% return every year reaches 3x in 10 years, 10x in 20 years, and 30x in 30 years. Your money invested today will multiply every 15-20 years.

But there’s a caveat. Warren Buffett’s said - “Rule No 1 - Never lose money. Rule No 2 - Never forget rule number 1.” Compounding formula breaks if investments are sold at losses and all those gains that one expects to benefit from long-term investing vanishes. In equity investing, compounding does not work straightforwardly. There are good times, and there are bad times. Investors tend to lose discipline, especially during bad periods, and therefore lose out on long-term benefits of compounding.

Hence - Invest early and invest long.

How not to choose investments?

Investing higher amounts as markets go higher - Disciplined investing requires investors to periodically investing. A SIP is a great strategy to maintain discipline.

Track Record - Blindly looking at short-term track record and choosing investments will lead to disappointment. Selling track record is the easiest way to sell funds, and so investors should look deeper into strategy and philosophy before proceeding.

Debt investors looking at yields - investors using yield as a measure will end up buying risky debt investments (credit funds) or investments that are very volatile (e.g., 30-year bond).

Market timing strategies - Various studies have shown that market timing destroys more value than it creates. For a long-term investor - it’s always a good time to start investing (especially if you’re doing SIPs).

High fees – Investors should look out for fees higher than usual. There are a few instances where fees is justified, but overall, investors should avoid paying too many fees.

How to do it the right way with index funds?

Simplicity - Index funds provide a whole level of simplicity to the process of deciding funds to buy for long-term investing. Instead of choosing between hundreds of investment products - index funds are stress-free and based on their track record - really effective investment products.

Look at living costs - The whole point of investing is to create an income that grows faster than living costs and save for retirement. Inflation is the biggest enemy, and equity is the only asset class today that beats inflation.

Focus on goals, not returns – Goal planning entails planning a SIP amount every month towards a long-term goal. Goal-planning helps in maintaining discipline and also helps investors see and track progress.

Focus on asset allocation - Based on numerous studies - 90% of long-term returns are because of asset allocation and not which fund one buys or sells. Index funds are great for asset allocation. A conservative investor investing in high-risk strategies will find it hard to hold to investments for long periods of pain.

Rebalance portfolio - A successful index fund investor should rebalance his/her portfolio at least once a year. If rebalanced with discipline - investors can expect to get additional returns. Rebalanced portfolios do better than static portfolios.

Lower costs - Investing in Index funds mean more money working for the investor. Costs add up in the long run.

Focus on risk, not return - Index funds provide a level of risk that is consistent with time. A large-cap index fund is less risky than a mid-cap and so forth. As they say - Returns are volatile and hard to predict, the risk is not.

No churn - Churn is also an enemy of the investor and leads to less long-term returns. Every strategy has good and bad periods. Studies show that investors who churn low performing funds with high performing funds normally lose further 1.5% in returns. Hence, investors should only churn for reasons other than returns.

Time - Charles Schwab said that ‘time captures the economy’s tendency to grow. It also helps you get past downturns and recession’. Other risks include funds merging and closing down. Index funds protect investors from these risks and others associated with time.

To summarize, successful investors are ones who invest early and ones who invest long.