Advait had just turned 23 when he began working with a large IT firm, which paid him a handsome salary. While his colleagues spent almost all their income on upgrading their lifestyles, travelling and partying, Advait was focused on setting aside and investing a portion of his salary each month. He had picked up this habit from his parents, who were both private sector employees – given the lack of a pension, they had begun allocating funds to their retirement corpus from the time Advait was young. And this helped him realise the importance of planning and compound interest when investing for financial goals such as secure retirement.
You may wonder why someone aged 23 should be so fiscally prudent, especially regarding retirement, which may appear so far off. As Pietros Maneos once said, “A penny saved is just a penny earned, unless of course you double that penny every day for 30 days, which is then $5,368,709.12.”
Retirement planning is a journey that must be marked by financial foresight, smart investment decisions, and a clear vision of a comfortable and secure future. You cannot invest all your money in riskier assets like equities in the quest for returns, and neither should you park all your funds in a fixed deposit, given the rising inflation and the comparatively low interest rates, which will end up eroding your wealth in the longer term. In investing, one strategy has gained considerable attention for its potential to help individuals achieve their retirement goals with lower costs and less stress, and that is index funds. Let us understand why index funds make an excellent choice for retirement planning.
What are index funds?
Index funds are a type of mutual fund or exchange-traded fund (ETF) that aims to replicate the performance of a specific market index, such as the Nifty 50. These funds are passively managed, meaning they do not rely on active stock selection by a portfolio manager. Instead, they mirror the holdings and weightings of the chosen index. The key principle behind index funds is simplicity – rather than attempting to beat the market, they strive to match its performance. This approach has several notable advantages that make index funds an attractive option for retirement planning.
Index funds in retirement planning
First and foremost, index funds are known for their cost-efficiency. Since they do not require the expertise of active fund managers or extensive research, they typically have lower management fees and expense ratios, translating to more of your money working for you over time. For financial goals like retirement, which are usually a decade or more down the line, the lower costs depicted by index funds can be an enormous bonus since high fees can eat away at your corpus. Secondly, when you invest in index funds, your portfolio gets diversified automatically, given the broad market or segment exposure offered by benchmarks like Nifty 50. This diversification helps spread risk and reduces the impact of poor-performing individual investments.
Another advantage of index funds is their consistency. The objective of index funds is to track an index’s performance, and this consistency can be particularly reassuring for retirement planning, as it minimises the uncertainty associated with actively managed funds. The passive nature of index funds is also a boon for retirement funds because managing investments can be stressful, especially as you near retirement. Index funds require less active decision-making, reducing the emotional toll often associated with market volatility. A key aspect also revolves around the historic performance of many index funds, which have outperformed actively managed funds, especially large cap funds, over the long term, making them a reliable choice for building wealth for retirement.
How to invest in index funds
Investing in index funds for your retirement plan can be done simply and efficiently by –
- Defining your retirement goals: Begin by determining your retirement goals, which involve setting the age at which you plan to retire, envisioning your desired retirement lifestyle, and estimating the income you will require during retirement.
- Evaluating risk tolerance: Take into account your risk tolerance, which may be influenced by factors such as your age, financial circumstances, and comfort level with market fluctuations. Index funds offer a range of options, from conservative bond indexes to more aggressive stock indexes, enabling you to align your investments with your risk tolerance.
- Selecting suitable funds: Conduct thorough research and choose index funds that best align with your retirement goals and risk tolerance. Look for funds with low expense ratios and a track record of effectively tracking their respective indexes.
- Opening an investment account: Open an investment account with a brokerage or financial institution. Many online platforms provide easy access to a wide variety of index funds.
- Emphasising diversification: While index funds inherently offer diversification, you can further diversify your portfolio by investing in multiple index funds that represent different asset classes, such as stocks, bonds, and international markets.
- Establishing automatic debits: Consistent contributions over time can help your retirement savings grow steadily. Set up automatic transfers to your investment account to ensure that you consistently add to your portfolio and benefit from the power of compounding interest.
- Rebalancing when necessary: Regularly review your portfolio and rebalance it, if required, to maintain your desired asset allocation. Rebalancing ensures that your investments stay in line with your long-term goals.
Retirement planning is a journey that requires careful consideration, sound strategies, and disciplined investing, and index funds have emerged as a powerful tool. By embracing index funds and aligning them with your retirement goals, you can enhance the likelihood of achieving the comfortable and financially stable retirement you deserve. Remember, the key to successful retirement planning is starting early, staying committed, and making informed investment decisions along the way.
Wealthzi is now a direct mutual fund app which allows you to invest in zero commission funds, including index funds. Wealthzi app is available on both iOS app store and Google Play Store for download. The users can open an investment account, track their mutual funds and stocks seamlessly for free. The app allows you do risk profile, and create a dream portfolio using a portfolio building tool according to your risk appetite. If you have an existing mutual funds portfolio, you can track the same easily by porting the data instantly via Wealthzi app. Users can do review of their existing portfolio using Wealthzi’s proprietary Zi scoring methodology.