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Are ETFs good alternatives to direct stock investments?

Are ETFs good alternatives to direct stock investments?

TLDR: ETFs, my preferred list, inbuilt diversification, long term return.


Exchange Traded Funds - ETFs are tradable funds which owns the underlying asset (be it gold, stocks or bonds) tracked by an index. The index itself can be created by various methodologies but in India, they are primarily by market capitalisation.

History

The first ETF globally to be listed was the S&P 500 in 1992 and it has spread like wildfire. Now the common joke in the US market is that there are more ETFs than there are listed stocks across all the stock exchanges. Now when it comes to India, the first ETF NIFTY BeES was launched in Dec 2001 but there has not been an explosion of ETFs in India unlike US.

Built-in diversification

The key benefit of an ETF is the built in diversification that comes with buying one. Let us take a look at my favourite ETF - Reliance NIFTY Junior BeES as a reference. This ETF tracks the NIFTY next 50 index, which consists of the 51st to 100th largest listed companies in India by market capitalisation. These firms broadly represent a wide swath of companies across different industries in the country. This by definition broadly represents the India market as a whole. Given the general trend i predict for the Indian market , this index is a good representation of the mix.

For a small investor to build such a diversified portfolio across all of these sectors by purchasing individual stocks is almost impossible and ETFs help with that quite easily.

My preferred List

There was a time in my stock trading days when i used to chase after “multi-bagger” stocks. Either buying them during the run-up or selling them before they lose steam or even holding for too long before they stagnate or even crash. Those days are behind me. With family commitments, work and the blog I hardly have any time during my day for anything much less spend time researching on stocks. This lead me to transition to ETFs and Mutual funds as my primary investment options.

For any diversified portfolio there needs to be a good spread across different industries and different size companies. I chose the following

  1. NIFTY BeES - Giant (tracks NIFTY - biggest 50 companies in India by market cap)

  2. NIFTY Junior BeES - Large (tracks NIFTY next 50 - 51st to 100 biggest companies in India by market cap)

  3. ICICI iWin Mid Cap - Mid cap (tracks - NSE Mid cap 100 index* , edited 8-Jan-19 to BSE Mid cap select index)

I don’t invest in them equally every month, but i use my discount technique to try and buy every month. So how are the returns on these funds over the last 10 years?

10 year historical SIP returns

  • Start date: 1-Nov-2008

  • End date: 31-Oct-2018

  • Number of instillments: 120

  • Monthly SIP: 10,000 (Rupees)

  • Total principal : 1,200,000 (12 lakhs or 1.2 million)

NIFTY BeES

  • CAGR = 11.83%

  • Maturity value = 2,200,578.70

Source :  Moneycontrol

Source : Moneycontrol

NIFTY Junior BeES

  • CAGR = 15.47%

  • Maturity Value = 2,666,629.53


ICICI Mid cap index has been launched relatively recently so there is no 10 year history that I can provide. But as you can see with the magic of compounding all these index returns are pretty impressive.

ETFs vs. Mutual funds

This is a logical next question, how do ETFs compare against mutual funds. Mutual funds by definition are actively managed portfolios by the respective fund managers, they come with higher expense ratios but some of the good funds have been consistently beating the indexes. I am not sure if it is sustainable in the future.

Also there is wider universe of mutual funds in sectors and areas where we have no ETF presence. Small cap funds, thematic funds, sectoral funds etc. are a few examples that come to mind.

For most investors who don’t have

  1. The finance know-how

  2. Patience to study market

  3. Review financial statements

  4. Understand the quarterly reports

  5. Constantly review and track stocks

I highly recommend not going into buying and selling of individual stocks. Why not take advantage of the diversification provided by ETFs and mutual funds and let the steady compounding and SIP work in your favour.


Happy Investing - #MyFatFIRE

Financial education

Financial education

The Magic of compounding

The Magic of compounding