Index funds are the latest talk of the town among stock market and mutual fund investors alike. As markets remain volatile through the Covid-19 pandemic and the ongoing Russia-Ukraine war, these funds are fast gaining the attention of many due to their unique characteristics. Index funds invest in stocks that form part of the underlying index and in the same proportion as the index. The fundamental principle they follow is to mimic the index composition and performance.
If you are looking to invest in index funds, here is all that you need to know to invest better in these.
Index funds primarily invest in stocks that are constituents of a benchmark index, such as the Nifty 50, Sensex, etc. These are passively managed and therefore offer lower expense ratios or management fees as compared to actively managed mutual funds.
It is very easy to invest in index funds. Here is how an investor can go about it:
Here are some tips that investors can follow while selecting the ideal index fund for investment:
Despite the range of choices offered under the index fund bucket, an investor can invest in one broad stock market indice to achieve portfolio diversification.
To know how an index fund works, we must first know how a passive investment differs from actively managed funds.
Actively managed mutual funds involve a fund manager who actively selects securities for buying or selling and makes decisions on when to transact. Since this requires time, effort, and substantial understanding of the markets, the fund will charge a management fee for investing in actively managed mutual funds.
Passively managed funds like index funds, on the other hand, involve a strategy that requires a fund manager to set up a portfolio of investments reflecting the benchmark index. However, since the fund will only track the index, there is no active role of the fund manager. The performance of the index fund will mirror the index performance, thus eliminating substantial management fees, also known as the expense ratio.
Index fund investments are easy and one of the most cost-effective wealth creation avenues for investors. By tracking and mirroring the performance of the financial markets, index funds can offer positive returns in the long run without requiring an investor to constantly monitor it.
Here are some of the top reasons why investing in index funds can be a sensible decision:
Despite the benefits listed above, index funds may not suit all investor expectations. Hence, some of the points that investors should consider before investing in them are:
Index funds continue to attract more investors as people prefer to follow the market instead of beating the market in the long run. As these are still new in the Indian context, it is important for investors to know the best ways to invest in these after having sufficient knowledge about them.
No, index funds are not difficult to understand. In fact, these are far easier to understand due to transparency around stock composition.
Passive investing involves lower fund manager discretion, lower expense ratio, and more transparency around portfolio composition. This is why it is preferred by many investors over active investing.
ETFs or Exchange traded funds are passive funds that can be explored apart from index funds.
Index funds generally have expense ratios below 1%. Investors should look for an index fund that has lower expense ratios as compared to other index funds.
No, index funds generally do not have a lock-in period and investors can exit them at any time. However, investors must carefully look at the exit load applicable on the scheme.
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