Index mutual funds are the type of passive funds that follow a certain index/benchmark to plan investments. The fund managers follow the index such as Nifty 50 or Sensex to invest money in the exact proportion. The returns on these funds are aligned with the underlying index.
These funds are safer than equity mutual funds, have lower expense ratios, deliver decent returns, and don’t need active attention. Investors who are seeking diverse portfolios with low to moderate risk can take advantage of the index funds.
Let’s shed more light on the index funds.
Index mutual funds in India either follow the Nifty 50 or Sensex as the investment benchmark.
Nifty 50 is the benchmark index that represents the top 50 companies listed on the National Stock Exchange. Sensex represents the top 30 companies listed on the Bombay Stock Exchange. These companies could be of any type and sector.
Fund houses allocate money to these top companies on Nifty or Sensex. The performance of the index funds completely depends on the performance of the underlying index.
It is always advised to hold these funds for a longer horizon to receive superior returns.
Index funds are a combination of companies from various sectors. Once you invest in index funds, you invest in all these companies without assessing them individually.
Not only does it save your time but also diversifies your investment portfolio.
Index funds are passive investments. Neither the fund manager nor you have to actively reallocate the funds to balance risk and returns.
Fund managers simply follow the underlying index benchmark and keep the investment as it is. No headache of active management.
Fund houses do not need to invest time and resources into analyzing the performance of the fund. They only have to reflect the benchmark into the investment allocation. To do so, they charge a very minimal expense ratio.
How much funds to allocate to a particular stock is always a question with mutual funds. Fund managers have to analyze the market to decide the percentage of funds to allocate to each company.
In index funds, the allocation bias doesn’t exist as the benchmark defines it all. There is less chance of human error as these funds are regulated with the index.
The fluctuations in the returns from index funds depend on the performance of the top companies from the underlying index.
Since Nifty and Sensex constantly track the performance of the companies, the risk can be lower. You have complete transparency about the risk factor.
As index funds are passively managed funds, they are less affected by market volatility. You will be able to earn decent returns even when the market is not at its peak. However, you may want to consider investing in some active funds to balance the returns.
Index funds are less riskier than equity funds. Market volatility doesn’t actively impact index funds. You may still get good returns compared to other actively managed investments.
Tracking difference is the difference between the gains of the index funds vs the underlying index. If it’s positive, the funds have outperformed the underlying index. Tracking error is the standard deviation of the tracking difference over a period of time. Fund houses make decisions based on tracking errors with respect to the underlying index. It can have either a positive or a negative impact on the returns.
Index funds deliver better returns in a long term. If you keep your investment horizon to 5-7 years, you are most likely to earn better returns. The rule applies to all mutual funds.
You may want to make yourself familiar with the index category. Index funds either follow the Nifty 50 or Sensex with variable or equal weightage. You can choose the index fund category based on your risk tolerance and portfolio balance.
The capital gains earned via Index funds are similar to the equity mutual funds. It depends on the duration of the investment.
If you redeem your investment before 12 months (Short term capital gains), you will have to pay a 20% tax. Investments held for more than a year (Long Term Capital Gains) above 1.25 Lakhs are taxed at 12.5%.
Index funds are not as risky as equity funds or stocks. So any new investor can start an investment portfolio with index funds. These funds are suitable for low-risk appetite investors.
However, index funds are also great to balance the risk. So if you have active funds which are prone to risk, index funds can balance your risk profile.
Always good to have a blend of active and passive funds in your portfolio.
The top two advantages of index funds are: these funds are passively managed and possess comparatively lower risk. If you are looking for a long-term, risk-balancing investment, index funds can chime in on your portfolio.
You may want to get familiar with the index categories before choosing a suitable index fund. Or you can always seek help from our expert advisors.
We recommend evaluating your portfolio before deciding on the right index fund for you. Write to us anytime with your investment goals. Get a complimentary portfolio analysis and start building wealth.
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