Most investors must have come across index funds, however not everyone might be familarised with these set of mutual funds. This article aims to serve as an investment guide in index funds which will aim to clear certain topics for you such as what are index funds and how can you use an index fund in your investment portfolio.
What are index funds?
Index funds are a type of mutual funds that imitate a prominent stock market index such as NSE (national stock exchange) Nifty, BSE (Bombay stock exchange) Sensex, etc. These funds are passively managed, which means that the fund manager buys similar securities in similar proportion as that of the underlying market index.
Can first-time investors consider investing in index funds?
Index funds can actually be a good investment option for investors new to the investing world. Why, you may wonder. Well, the equity markets tend to be volatile during a short duration and index funds can be a good investment avenue to get used to this volatility through a small exposure. What’s more, index funds make the choice easier in choosing the right investment options for one’s investment portfolio. Once an investor is familarised with the volatility faced by the markets, they can gradually shift to actively managed funds. Index funds can also be used to diversify one’s investment portfolio.
Benefits of index funds
Let’s understand some of the benefits of investing in index funds. Read on to understand these advantages:
- Low expense ratio
As an index fund successfully tries to imitate their underlying stock market index benchmark, the need for an efficient team of fund managers and research analysts reduces to a great extent. Also, as a fund manager does not has to actively trade stocks, it also adds to the reason of low management fees or expense ratio on passively managed fees as compared to actively managed funds. Thus, investors investing in index funds enjoy low expense ratio.
- No bias investing
Index funds follow the concept of regulation-based and computerized investment system. The fund manager is expected to follow a distinct mandate of the amount to be invested in index funds in different types of instruments. This removes any sort of bias or human discretion.
When you invest your money in securities with their proportion alike to that of an underlying stock market index, it ensures that the investment portfolio is well diversified across different stocks and sectors. For example, investing in the Nifty 50 index fund, an investor enjoys varied exposure across 50 different stocks spread across different sectors, ranging from metals, IT (information technology), pharma, oil and gas, telecommunication to banking.
- Tax advantages
As index funds are passively managed mutual funds, these funds typically enjoy small turnover, i.e. fewer trades positioned by a fund manager in a given financial year as compared to actively managed funds. Fewer trades results in fewer capital gains distributions which results in lesser tax implications on mutual fund investments.
Before you decide to invest in index funds, do not forget to check the fund’s expense ratio, nature of index, tracking error, and other factors. Happy investing!