Best Index Funds in India for 2021 - Top Index FundsIndex funds have recently been in the limelight due to the superior returns generated by them against equity mutual funds. Index funds are the cheaper alternative of actively managed funds.In this article:
- What are Index Funds?
- How does an Index Fund work?
- What are the advantages of Index Funds?
- What are the disadvantages of Index Funds?
- Who should invest in Index Funds?
- How are index mutual funds taxed?
- List of best index funds for 2021.
What are Index Funds? – Meaning of Index Mutual FundsIndex funds are passively managed equity mutual funds. An index fund tracks a particular benchmark index. Hence, they are known as Index Funds.The Securities and Exchange Board of India, SEBI defines index mutual fund as, ‘open ended mutual fund scheme which replicates 95% of assets of its benchmark’.An index mutual fund copies the stocks and their composition from the benchmark index. Index mutual funds are passively managed. This means that the fund manager does not take an active interest in managing the portfolio. The fund manager’s goal is to simplify mirror the returns of the index.Index funds are cost effective as fund management charges are very low. For example: The expense ratio for UTI Nifty Index Fund is only 0.14%. In India, NSE’s NIFTY 50 and BSE Sensex are popular benchmarks for index mutual funds. A NIFTY index fund will have the same 50 stocks, in the same weightage as in NIFTY 50 Index. A Sensex index fund will invest in 30 stocks, in the same proportion as in Sensex.
How Does an Index Mutual Fund Work?The fund manager of an index fund buys the same stocks with the same weightage as the index.An index fund with NIFTY 50 benchmark will invest in all 50 stocks of NIFTY in the exact same proportion.So, if NIFTY 50 has 10.29% allocation to HDFC Bank Ltd then your index mutual fund will also have 10.29% allocation to HDFC Bank Ltd.
What are the Advantages of Index Funds? – Advantages of Index Mutual Funds1. Low Cost: Index funds are passively managed. Hence, they charge very little management fees. For example, The benchmark for Axis Bluechip Fund is Nifty 50. The expense ratio for the fund is 1.78%. But the expense ratio for Axis Nifty Fund is only 0.15%. Low cost is the main reason behind index mutual funds' rising popularity. 2. Elimination of Management Errors: The fund manager of an actively managed fund is constantly under pressure to beat the benchmark. So, he invests in various companies to increase profit. This is a double-edged sword. One wrong investment decision can lead to huge losses. This does not happen in an index mutual fund. In an index fund, the fund manager has no scope to change the allocations. Hence an index mutual fund eliminates management errors. 3. Diversification: Normally an index consists of companies from various sectors. This diversification means that investors get to invest in top companies as per market capitalisation. Diversification also helps reduce overall portfolio risk.
What are the Disadvantages of Index Funds? – Disadvantages of Index Mutual Funds1. Lower Returns: Since the fund manager does not aim to generate superior returns, he does not take active investment decisions. This leads to lower returns than actively managed mutual funds. For example: Even if the fund manager believes HDFC Bank Ltd will give high returns in the future, he cannot increase the allocation from 10.29%. But this freedom is available with fund managers of actively managed mutual funds.Historically, actively managed mutual funds have generated superior returns than index mutual funds. 2. No Control on stock selection: At times, the index might have a poor-quality stock which is not worth investing. While an active fund manager can avoid investing in poor quality stock, the fund manager of an index fund has to invest in the stock as it is a part of the index. A classic example of this was Satyam. The company had poor corporate governance. But since it was a part of the index, fund managers were forced to invest in the stock. When the fraud was discovered, Satyam was removed from the index, but the damage was already done. Investors had to bear substantial losses.
How are Index Mutual Funds Taxed?Index mutual funds follow equity taxation. The holding period for index mutual funds is 12 months.
- If you sell your units before 12 months – You pay a short-term capital gains tax of 15%.
- If you sell your units after 12 months – You pay a long-term capital gains tax of 10% only above Rs 1 lakhs.
- If you sell your units after 12 months but the gains are less than Rs 1 lakhs, then you pay no tax.
What is the Difference Between Index Mutual Funds and Exchange Traded Funds (ETFs)?There is only one difference between index mutual funds and ETFs. ETFs are traded on the stock exchange. But index mutual funds can be bought and sold only through the fund house.So, you can sell ETFs at different prices throughout the trading day. But an index mutual fund can be bought and sold only as per day’s closing NAV.
Who Should Invest in Index Mutual Funds?Investing in index funds is a great investment strategy for investors who want to get similar returns as the index.Index fund investing is also advisable for investors who want superior returns at low costs.Long-term investors looking to mirror market risks at low cost can invest in index mutual funds.Investors who want to outperform the market and generate superior returns should invest in actively managed mutual funds instead.
Factors to Consider Before Investing in Index Mutual Funds
- Tracking Error: Tracking error is the difference between the returns of the fund and its benchmark. You should always invest in index mutual funds with the least tracking error.
- Expense Ratio: There is very little management in index funds. Hence the expense ratio of index mutual funds should be as low as possible. Lower the expense ratio, higher your overall returns.
- Investment Horizon: If you have a long-term investment horizon, then you should invest in actively managed mutual funds rather than index funds. Actively managed mutual funds have a proven track record of generating superior long-term returns than index funds.
How to Invest in Index Mutual Funds?There are two ways of investing in index mutual funds:
Best Index Mutual Fund – Best NIFTY 50 Index Funds
|Nifty Based Index Funds||1 Year||3 Years||5 Years||10 Years||Expense Ratio|
|UTI Nifty Index Fund||24.11%||12.84%||15.77%||11.35%||0.14%|
|HDFC Index Fund - Nifty50 plan||23.70%||12.64%||15.58%||11.29%||0.30%|
|ICICI Pru Nifty Index Fund||23.74%||12.30%||15.16%||11.21%||0.45%|
|SBI Nifty Index Fund||23.13%||12.11%||15.11%||10.77%||0.48%|
|TATA Index Nifty Fund||25.45%||13.58%||16.34%||11.37%||0.50%|
Best Index Mutual Fund – Best SENSEX Index Funds
|Sensex Based Index Funds||1 Year||3 Years||5 Years||10 Years||Expense Ratio|
|Nippon India Index - Sensex||24.39%||13.12%||16.01%||11.88%||0.05%|
|Kotak Sensex Fund||24.38%||14.45%||16.67%||12.05%||0.28%|
|ICICI Prudential Sensex Fund||24.86%||14.13%||-||-||0.30%|
|HDFC Index Sensex Fund||25.76%||15.33%||17.51%||12.12%||0.30%|
|TATA Index Sensex Fund||24.83%||15.02%||16.99%||11.51%||1.00%|