Not sure whether I will be lynched for this article, but as usual I am not giving an answer. Let me put both the sides of the argument, and you can pull your hair over what you should do. Let me start with a caveat, if you are not allocating about 80% of your overall investible surplus to equities, your PORTFOLIO return will not be very much influenced by your asset allocation. If you have all the time in the world, the requisite skills, the data tools required, the brain to do it…you may not be able to spot funds/ schemes which will CONSISTENTLY beat the index.

CAVEAT: Personally I have no investment – or a put option in an index fund.

Also  the importance of investing regularly, not interrupting compounding, being clear that equity does not have a clear time frame, but can sometimes test your patience for very long periods of time – is a given.

Let us look at the  arguments AGAINST investing in an index fund:

1. Even internationally it is difficult for fund managers to beat a Russell kind of an index – because it is a broad based index. So beating a Sensex may be easier, but beating a BSE 100 maybe more difficult.

2. In India the Indices are poorly constructed (I do believe this) – this means many fund managers are able to beat the sensex. Let me rephrase it – many fund managers have been able to beat the index over the past 35 years that the index has been around.

3. I have been extremely lucky that I chose Franklin India Bluechip, Hdfc Top 200, Hdfc Equity, Prudence, I Pru Discovery, – and these funds have all beaten the indices over long periods of time. Attribute it to my luck.

4. Index manufacturers are like rating agencies, they react too late. Historically there can be an argument that the companies that they remove from the index TOO do well – in fact many a times they do better…

The Arguments in favor of Indexing:

1. Easy to understand – just pick the fund with the least tracking error. Tracking error takes cost, churn, waiting time – and is one good figure to judge the fund performance.

2. Too much attention is not required on a day to day basis about where to invest, when to switch, etc. As long as you want to be in equities you can be in one fund, and be done.

3. Today inexpensive index funds are available, and going forward the number of  funds that beat the index will only go down.

4. Fund managers which do well many a times are closet index funds which do just a little better – to nullify the asset mgt charges.

5. As bigger indices keep getting better managed and representative, the fund managers may find it difficult to keep pace with the index….