What are Index Funds?
Index funds are mutual funds or exchange-traded funds (ETF) that are composed to track the performance of a particular index such as Sensex and Nifty.
An investor can choose any investing method among two to invest in index funds either by ETF or by the mutual fund.
The Sensex as you may aware consists of 30 stocks in proportion to their free-float market capitalization from 13 different sectors in order to calculate the performance of Bombay Stock Exchange top 30 companies.
Likewise, Nifty consists of 50 stocks in proportion to their free-float market capitalization to calculate the performance of the top 50 Companies listed on National Stock Exchange.
By knowing the stock market indices we can easily evaluate the overall performance of the stock market by capturing the price movement of the top companies stock belonging to different sectors supported by their market capitalization.
As you and I Know that at the same time all the sectors are not down, So these funds usually give good returns to the investors who invest in index funds.
There is no need for the Fund manager especially in case of index funds, As Index funds are used to track the particular index and collecting the stock in the exact same portion as the present in the benchmark index(Sensex or Nifty).
Why index funds?
Index funds have benefited from many things. These include re-classification of mutual funds, the introduction of the Total Return Index (TRI) as a benchmark, etc. It has created an atmosphere for index funds. Investors have increased interest in these funds.
How does index fund work?
- Let’s take an example of how index fund work, Suppose the stock of Infosys Ltd has a weight of 7.75% on the Sensex, Then an index fund tracking the Sensex would use 7.75% of its fund to buy that particular stock
- If another stock has a weight of 7%, then the index fund would allocate 7% of its funds for buying that stock.
- By choosing index fund you have a portfolio which is fully diversified, consisting of some best companies in their sectors.
Features of Index funds:
- Low cost: These are less expensive as compared to other mutual funds.
- Low expense ratio: This is, in fact, the biggest advantage of index funds is the role of the fund manager is limited to the cost saving is transferred to investors.
- Diversified: Investors can achieve diversification and wide exposure to different sectors and big companies having high market capitalization.
- Liquidity: Index funds are highly liquid in nature.
- Lack of flexibility: Index funds are supposed to match the footsteps of the index they follow. This reduces the flexibility of changing your holdings.
How to Invest in Index Fund?
We can not directly buy index funds, therefore we can contact any mutual fund company and invest our money in their index funds. You can purchase direct plans on their website. Apart from this, you will also have the option of Growth and Dividend Pay Out, in which you can choose any but Growth option is better, and besides its up to us that what kind of investment suit for us whether we want a Lump Sum or SIP, If we would need to choose then SIP option is better. For Example
If you invest in a Sensex index fund which providing 17% CAGR from the last 35 years, Your returns would be 2 crores 5 lakh rupees by simply doing SIP for Rs 500 for the next 40 years.
Advantages of Index Funds
Investment in Economy – STOCK MARKET INDEX of any country does not just REPRESENT the stock market of that country but REPRESENT the whole economy of that country, and in such a way the investment in INDEX, in that country’s economy As investment can be seen.
LONG TERM All the economy will work well, this is the basis of any investment, and by investing in INDEX FUNDS we invest in a whole economy.
NO ROLE OF FUND MANAGER – There is no role of FUND MANAGER to select the stock in this fund, and in this way we avoid possible mistakes by a fund manager, in this way, if the index fund does not have DEPEND at FUND MANAGER, Rather PROCESS DEPEND, and once the set of index funds and PROCESS starts, this CONTINUE continues.
PASSIVE MANAGED FUND – If seen on the basis of managing the mutual fund, there are two types of mutual funds, an active managed FUND – in which fund manager ACTIVELY analyzes the stock and buys BUYING AND SELLING,
On the other hand, there are also mutual funds, which do not require ACTIVE management, and such funds are invested in the companies involved in the index, like – INDEX FUNDS
The investor first knows that his money will be invested in the company of the index, and thus the investor can be sure that his money will be invested in the company, which will be doing the best.
LESS EXPENSIVE RATIO – In this way INDEX FUNDS reduces the need for a manager or a particular team to reduce the expense of index fund, and this is the reason that index fund is less than other ACTIVELY MANAGED funds. , And this type of fund is near the EXPENSE RATIO 2 to 1%,
And in this case, investing in the index funds is the lowest fee charge compared to any other mutual fund.
It is easy to understand and invest in INDEX FUNDS -A common man, who does not know anything, what is the stock market, how he works, but he knows so much that when he was younger he could buy anything, today his children are able to buy more than that, And so in the LONG TERM the entire economy goes forward in a long time.
And in this way, the common man can easily understand INDEX which is an indicator of the economy of the country.
Easy to understand index funds, it is easy to invest in it, even if it is INDEX FUNDS of any company, it does not make much difference, its profit will be the same, which will be of the main index.
Disadvantages of Index Funds
- You can’t select the stock as it copies the index.
- As we are in under developing nation so we can’t expect more than average returns.
- As index goes low directly impact to index funds.
Should we need to Invest in index funds?
Mutual fund advisors say investors are turning towards index funds. But, its speed will not be fast. There is still the advantage of choosing good shares in Indian markets. It is expected to continue even further. Therefore, investors can get slightly higher returns in active management funds.
To get the advantage of Investing in Index funds, First of all, you need to make long term investment goal it could be 15 years or more, 20 years, 25 years, 30 years, or sometimes more than 30 years but it should not less than 15 years. Due to some ups and down in the Stock market, if you invest in an index fund for less than ten years, then You do not have too many benefits.