Why are index funds popular in other parts of the world?

Index funds are considered as ideal for constructing a core portfolio for long term wealth creation due to their diversification benefits, low cost and low portfolio churn. Globally, Index funds are popular due to the following reasons –

1. Easy - Index funds are simple to understand and track, as they usually track the broad-based indices that are publically available. Further, the index values and composition is generally publically available, which helps investors know exactly their portfolio holding at any point in time. Unlike active funds, investors don’t have to fret over with fund’s under-performance, or the fund manager’s stock/sectors selection style, before making an investment decision.
   
2. Economical – Passive funds don’t need an active decision in terms of stocks or sector selection which reduces the overall expense ratio as compared to active funds. TER of passive funds typically ranges between 0.05% and 0.50% which is considerably lower than active funds.
   
3. Effective: Index funds generate benchmark returns after deducting for fees and expenses. There is no risk of underperformance or outperformance and removes any emotional bias from investments making it easier to stay invested for a longer term which ultimately leads to wealth creation. Further Index Funds helps in achieving effective asset allocation in the portfolio, since they generally don’t deviate/drift from risk mandate, for example in Large-cap, mid-cap or small-cap Index Fund would always include respective size category of stocks, and periodic index rebalancing will help realign the size exposure of the fund. 
   
4. Increasing Market Efficiency - As markets grow and mature, they become more efficient. Globally it is observed that, with increasing market efficiency, the ability to generate alpha is diminishing. This market efficiency has led to a decline in active fund performance in developed nations across the world. As per the SPIVA year-end 2020 report, 75% of active funds underperformed their benchmarks over a 5 year period in Europe and the USA. Similarly in Canada, 99% of active funds underperformed their benchmark and in Japan 70% underperformed their benchmark over the same time period.·Their survivorship is also in question as typically only 62% of all domestic funds in the US survived over 10 years.

“Don’t look for the needle in the haystack. Simply buy the haystack.” 

- Jack Bogle, famous investor and major proponent of index funds

• Related Articles

• Who manages Index Funds?

  Just like actively managed mutual funds, index funds are also managed by fund managers. But fund managers have a little role to play, because constituents of index funds seldom change. Managers just buy and hold all the securities of a particular ...

• Why should you invest in index funds?

  Low Cost: Since index funds are passively managed, the total expense ratio (TER) is very less as compared to the actively managed ones. While an actively managed fund may charge you anything between 1-2% as TER, an index fund would typically charge ...

• Why should you not invest in index funds?

  Index funds are built to replicate the index and most active fund managers charge fees to outperform indexes. Therefore, an investor who is purely looking to do better than the index should not invest in index funds. It’s important to point out that ...

• Are all index funds the same?

  All index funds are not same because different index funds track different indices. But the philosophy behind investing remains the same.  There are different types of indices in India: Benchmark indices like BSE Sensex and NSE Nifty Sectoral indices ...

• Who should invest in index funds?

  Index funds are suited for passive investors, i.e. investors who are looking to build long-term wealth but: Don’t have time to manage their portfolio Want to stay away from constant monitoring and juggling their mutual fund portfolio. Are skeptical ...