How are returns in a Index fund calculated?

POSTED BY rajat ON February 18, 2011 12:32 pm COMMENTS (5)

I want to know how does returns from a Index fund is calculated. I have a ULIP which invests 100% in index fund over a period of 20 years. Today nifty is 5500+ and in next 10 years it might reach to 10000+ or more but at the end of my policy term i.e after 20 years it is possible that it again comes back to 8000 or even less than 5000. In such a scenario will I be in a loss as it might be possible that I might not get any return at all or even negative return.

I don’t know how index fund functions, can anybody tell me if my hypothesis is correct?

5 replies on this article “How are returns in a Index fund calculated?”

  1. rajat says:

    Thanks moneyinsights. My investment is 2 years old now. I hold Aviva life saver super policy. I don’t think i will be able to surrender it now as in my policy the first year premium was not invested and as per them it will be used to provide me loyality bonus in 5+ years. So In order to recover that money I have to be invested for more than 5 years.

    I think option 2 suits me. I wanted to ask you should i try to use top up when markets are down in order to get better return. If my surrender value will be equal or more than 12% annualized return in any of 5+ years, I will surrender the policy as I will be happy to get out of a bad investment.

    1. says:

      Hi Rajat,

      Just be sure about the fund performance & top-up charges before you decide to put more money. If the fund is performing below average then there is no point in putting more money behind it. However, if the fund performance has been consistently good – in up-market as well as down-market trends – it can really bring down your overall cost.

      You have to use the top-up & fund-switching very judiciously to gain more. There is no point in continuing to bet on a wrong horse if its not improving 🙂

      Hope this helps.

  2. says:

    Dear Rajat,

    Your hypothesis is bang-on. And so is @bharat shah’s.

    We have 2 options for you. Choose the one which you are comfortable with.

    Option 1 –
    ULIPs are an expensive way to invest your hard-earned money. We don’t know if you have bought very recently (less than 15 days ago?) because there is a free look-up period of 15 days. So you can surrender w/o much penalty.

    However, if you have crossed 15 days & bought after September 1, 2010 then there is a maximum charge of Rs. 6,000 that the insurance company can levy. You will get the balance amount after 5 years with 3.5% interest.

    But, if you have been putting money for more than 4-5 years, it may not make much sense to surrender.

    If you don’t intend to surrender, here is Option 2.

    Option 2 –

    You can avoid your hypothetical situation “completely” by being slightly responsible & proactive. Here is how –

    1. Make a resolution that you will start managing this policy actively i.e. keep an eye on the fund value every 15-18 months. If you feel you have gained enough & then use 1 innovative feature of ULIPs – “Fund Switching” option. Switch part of your fund value in Debt fund option.
    2. Using fund switching every 2-3 years (use judiciously or take help of an Advisor to decide the time & amount) & use will be able to secure your capital.
    3. Make a rule for yourself that after 15th year, no more than (say) 50% of your fund value should be in equity (i.e. NIFTY in your case).
    4. Over 16th to 20th year, gradually reduce your equity exposure of fund value, to almost nil.

    This way you “will be able” (NOT may be able) to gain optimally. So, in 20th year even if NIFTY falls from 15,000 to 10,000, you would have gained.

    Hope this helps. Happy investing 🙂

  3. Ramesh says:

    20 years is a very long time.

    do you think the sensex index can go back to 1178 (that was the level in 1991)?

    And flipping it over, could you have imagined that the sensex would be around 20000, 20 years ago.

    That is the same as to think about a level of 3,00,000 of sensex in today’s terms. Your mind is not equipped to deal with those values. Our mind can only think about the near past and near future, not so many years forward. 😉

  4. bharat shah says:

    i think, your hypothesis is correct. moreover you have to pay different charges for ulips, which predominantly makes ulips unattractive .of course mostly for such long period index may test different levels, and may not end as you assume. so better go for term insurance + suitable investment/savings assets as per your liking, may it be equity mf, debt, gold/silver, realty or mixed of them. you would have better liquidity, better hold to change, better return.

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