Index fund investing has long been a favourite strategy among passive investors seeking market-matching returns without exerting much effort. While index funds provide a convenient and diversified means to achieve market returns with minimal effort, the question remains – Does an investment of only Rs. 25,000 yield significant returns? Read on to explore this potential and examine factors that could have an effect on its potential returns.
What are index funds?
Index funds are mutual funds or exchange-traded funds (ETFs) designed to replicate the performance of an index such as the Sensex or Nifty 50 by investing in similar stocks in similar proportions as its index underlying. By taking this passive approach to invest, index funds typically result in reduced fees and expenses than actively managed funds, making index funds an affordable choice for investors.
Compounding to increase returns
A key to unlocking significant returns from small investments of Rs. 25,000 lies in compounding. Compounding refers to earning returns on your initial investment as well as on its returns generated. As time goes on, your returns compound and increase significantly; further compounding increases overall returns.
Let’s say you invest Rs. 25,000 in an index fund offering an average annual return of 12%, your investment would have grown by 112% after one year to Rs. 28,000 (25,000 * 1.12), then after two years reinvesting that profit would grow even further – ultimately compounding can turn your initial 25K investment into something substantial.
Factors affecting returns
Your returns from investing Rs. 25,000 in index funds depend on a variety of factors, such as:
Market performance: Index funds typically follow a specific market index, and your returns will largely depend on its overall performance. Stock markets historically have yielded positive long-term returns despite short-term fluctuations and cycles.
Investment horizon: Keeping invested for longer provides your investments with more time to grow, increasing potential returns. A long-term horizon also helps minimize any short-term market fluctuations that might threaten returns and ensure smooth returns over time.
Expense ratio: Index funds generally offer lower expense ratios than actively managed funds, yet it’s essential to carefully consider their fees on returns. A lower expense ratio allows more of your returns to be reinvested back into your portfolio for compounding, providing additional advantages from compounding
Increased investments: Making additional investments periodically through lumpsum or systematic investment plans (SIPs) could significantly boost your returns and overall performance.
While investing Rs. 25,000 once may not produce life-altering returns, it can serve as a good start towards building wealth if combined with compound interest and long-term investments. Furthermore, making regular contributions and reinvesting returns will further amplify your returns over time.
Establish realistic investment expectations that align with your financial goals in order to maximize returns. Diversifying your portfolio, keeping costs low, and remaining invested for an extended period are all strategies designed to increase returns. Even small investments can yield substantial dividends with time and the right strategy in place.