In this article, we will discuss
- What are Index Funds?
- What Are the Features of Index Funds?
- How to Invest in Index Funds in India?
- Advantages of Investing in Index Funds?
- Disadvantages of Investing in Index Funds
When it comes to investing in mutual funds, index funds are one of the most straightforward options available to investors. They have gained rapid popularity in these past few years among investors due to their consistent returns and ease of management.
In this blog, we will discuss the meaning of these funds, their pros and cons and how you can choose the right fund for you. Read on to know more!
What are Index Funds?
An index fund is a type of mutual fund that tries to replicate the performance of a specific index. It does so by investing in the same stocks that are part of a specific index in a proportion which is also similar to the index. The goal of the fund manager of these funds is to track the performance of the underlying benchmark and generate similar returns as per the growth of the index.
To better understand it, let’s take an example. Suppose there is an index fund that tracks the performance of Nifty 50. For those who are unaware, Nifty 50 is made up of the 50 biggest Indian companies in terms of market capitalisation.
Hence, an index fund that tracks the performance of Nifty 50 will also have stocks of these 50 companies in its investment portfolio. The fund manager’s primary goal would be to generate returns just like the Nifty 50.
What Are the Features of Index Funds?
Here are some key features of these funds:
- The fund manager can choose to invest in equity or equity-related instruments to mimic an index.
- These are passively managed funds because the fund manager doesn’t have to actively research for stock to include in the investment portfolio of the fund.
- These funds always aim to mimic the performance of an index and not to outperform their benchmark.
- Depending upon any changes occurring in its underlying index, the fund manager also makes relevant changes in the fund’s portfolio.
How to Invest in Index Funds in India?
With these simple steps, you can easily start investing in index funds and thus begin your journey of passive investing.
Step 1: The first step to start investing in these funds is to choose an index that matches your investment goals.
Step 2: Research different index funds that track the performance of the index you chose. Make sure to check for any tracking errors or if the fund has any deviations from the original index.
Step 3: Choose if you want to invest directly through the website of the mutual fund or through a broker.
Step 4: Depending on your choice, open an account either on the official website of the mutual fund or the stockbroker you chose. You can choose the Samco New-Gen app to open an account and start investing.
Step 5: Fill in the necessary information and complete your KYC.
Step 6: Add the requisite money to your account to start the investment.
Step 7: Place your index fund order and choose the number of units you wish to invest in. Lastly, you can also choose to set up a standing instruction with your bank if you wish to invest via the Systematic Investment Plan (SIP) method.
Advantages of Investing in Index Funds
Investing in these funds comes with a lot of advantages. Here are some of the major ones:
- Since these are passively managed funds, they come with a lower expense ratio and other fees. This allows you to divert more capital towards the investment.
- Investing directly in the stocks of an index can prove to be quite expensive. With index funds, you can track the index of your choice and reap similar returns without having to invest a big sum of money.
- Since the asset allocation of the index fund is spread over all the stocks of an index, it adds an edge of diversification to your portfolio.
- While all fund managers are highly knowledgeable and hold a lot of experience, a difference in opinion and judgement can impact the returns of the funds. Index funds eliminate this probability because the fund managers do not choose the stocks to be added to the portfolio.
- Since these funds have very low volatility, they are an excellent choice for investors with lower risk tolerance.
Disadvantages of Investing in Index Funds
Here are some disadvantages of these funds that you must consider before investing in them.
- If you are one of those investors who want to generate returns higher than the market, these funds are not the right investment choice for you. Rather, active investing will suit your goals better.
- Since the performance of these funds depends on their underlying index, if the index dips, so will your investment.
- Since it is a club of different stocks, you might be forced to invest indirectly in some stocks that you don’t want.
Index funds have, over time, often outperformed other actively managed funds and have successfully become a popular investment choice. However, they come with their own set of pros and cons that we have briefly discussed above.
If you wish to start investing in index funds or explore the stock market, open a trading account on the New Gen Samco Trading app today.
Frequently Asked Questions
Q1. How are index funds different from exchange-traded funds?
Ans. While they are quite similar, one major difference between these two funds is that the units of exchange-traded funds can be traded on stock exchanges, but the same is not applicable to index funds. Hence, you need a demat account for ETFs but not for index funds.
Q2. What are the factors to keep in mind while choosing an index fund?
Ans. An investor must consider their risk tolerance, investment goals, type of stocks they want to invest in and the expense ratio of the fund as well. Make sure to also find out any other charges the fund levies.
Q3. What is expense ratio?
Ans. This is the expense a fund incurs on its portfolio management, administration, and marketing of the fund. It is expressed in the percentage form and levied on investors to cover the cost.
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