Who Should Choose An Index Fund?

Do you want to start investing in equity markets but are unsure how to begin? One of the easiest ways to start is with an index fund.

With dual incomes and no dependents, these couples typically What is an index fund?

An index fund is a passive mutual fund that tracks the underlying market index. This index can vary from a broader market index like Nifty 50 or BSE Sensex, or it could be a sectoral index like the banks, IT, FMCG etc. In the case of an index like the Nifty 50, the index is designed to represent the top 50 companies operating in the country in terms of market capitalisation.

By investing in an index fund, an investor gets exposure to companies as per the index’s proportion. For example, HDFC Bank has a weightage of 10.97% in the Nifty 50 index. This means that any index fund that tracks the Nifty 50 index has to invest 10.97% of its assets in HDFC Bank. Given this setup, an investor will get returns similar to that of the underlying index.

Advantages of Investing in an Index Fund

Low cost: One of the major benefits of index funds is their low cost. Index funds typically have a lesser expense ratio than actively managed funds. The expense ratio represents the total expenses the fund house charges to manage your money. In an index fund, the fund manager is solely responsible for tracking the index, and so the cost of managing the fund is low.

No fund manager bias: Index fund managers do not make any active investment decisions. Hence, index funds are devoid of fund manager bias. In the case of actively managed funds, the portfolio is greatly influenced by the view of the fund manager. Hence, there is a case of bias creeping up over the years which could prove to be detrimental in case the calls go wrong.

Saves time: If you were thinking of investing directly in the stock market, you might have realised that direct investing takes time and requires expertise. Post-investing, one will have to track the company, sector, and the economy as a whole to understand if the investment thesis still holds true. All of this can be very tedious for a lay investor. One can circumvent all of these challenges by investing in an index fund. Moreover, index funds are simple to understand and require no specialised talent to enjoy a good investment experience.

Affordable investment option: Just like investing in any other mutual fund, an investor has the option of SIP or lump sum investment in an index fund. SIP investment can be initiated with as low as Rs.100 or Rs.500, making it accessible to one and all.

No demat account required: The process of investing in an index fund is just like any other mutual fund. Unlike other passive forms of Investment like ETFs, you do not require a demat account to start investing in an index fund. You can simply complete your KYC and start investing.

Increasing Popularity

Over the past four years, investors have been increasingly opting for index funds when it comes to taking exposure to the large cap space. However, the point that one should be aware of at all times is that the return profile of an index fund will be similar to that of its underlying index and there is no scope for outperformance like in the case of actively managed funds.

Sooraj Raveendran, Index Funds Distribution Private Limited

Disclaimer

The views are personal and are not part of the Outlook Money editorial Feature.