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Index Funds

The popular advice, “Do not put all your eggs in one basket” applies best when it comes to investments. Most investors know the benefits of diversifying their portfolio across different funds. Index funds are one of the best choices as they refer to funds which invest in the wider market index like Nifty and Sensex. All the stocks in these indices have different characteristics and the performance of the funds is identical to the performance of the index. The value of the fund is correlated to the benchmark index. The NAV (Net Asset Value) fluctuates as per the rise and fall in the index. One of the main USP of index funds is low expense ratio as these funds do not need monitoring actively by the fund manager.

Benefits of Index Funds

Low Operating Cost

Index funds do not need to be actively managed by the fund manager and hence, is passively tracked in nature. This is the main reason for the low expense ratio of index funds.

No Chance of Error from the Fund Manager

There are no chances of error of judgment or poor management resulting in a loss for the investor as they are not managed actively.

Guidance to Indices from Economist

The major economist gives their guidance and support to indices which no fund manager or investor can excel in the long run. There might be a case of price errors of stock which are amended as per their fundamental value. Hence, it is more likely that an index fund will manage to outperform active funds in the long run.

How do Index Funds work?

Index funds align themselves to a benchmark of Indices like Nifty and its portfolio will contain 50 stocks in the exact same propositions that comprise Nifty. An index group is a group of securities which define a market segment. These securities can be equity oriented or debt oriented instruments like stocks. The popular indices in India are NSE Nifty and BSE Sensex stock indices. Since index fund track a respective index, they do not need to be managed actively and hence, fall under passively management fund. The fund manager only has to decide which stocks need to be purchased or sold as per the composition of the underlying benchmark.

There is no need to have a team to research and identify opportunities to select stocks in index funds. Whereas, the actively managed funds endeavours to beat the indices benchmark, index funds goal is to match the performance to its particular index. Normally, index funds do deliver returns close to its benchmark. However, sometimes there can be a slight difference between the index and the fund performance and it is known as tracking error. The fund manager’s job is to ensure to minimise the occurrences of tracking error.

How to Invest in Index Funds?

Due to the penetration of internet and digital platforms, it has become easier to invest in index funds. There is no longer a requirement of lengthy paperwork documentation and the procedure of investing has become user-friendly. Today, an investor can simply invest through online digital platforms.

The normal procedure that an investor has to go through is mentioned below:

  • Sign in to the online portal of your choice
  • Fill the necessary information like your personal details regarding the amount of investment and duration of the investment
  • Get your e-KYC done through online verification
  • Choose and invest in your preferred index fund from amongst the hand-picked mutual funds.

Who Should Invest in Index Funds?

The decision to invest in a mutual fund solely depends on the risk taking capacity of the investor and his or her investment goals. Index funds are an ideal choice for investors looking for low risk investment and more or less predictable returns. Index funds also do not require active day to day management. For instance, if an investor wants to invest in equity funds, but does not want to take the risk of actively managed equity funds, then he or she can go for Nifty or Sensex index fund. Index funds will match returns of the particular index’s performance; however if the investor wants the opportunity to get returns beating index performance, then he or she will need to go for actively managed funds. It is believed that returns of the index funds might match the returns of the actively run funds in the short term, but in the long run, the actively managed funds give better returns.

Top Index Funds in India in 2019

Below are some of the top Index Funds in India for the year 2019

Fund1 year return3 year returns5 year returns
Franklin India Index NSE10.67%13.76%11.73%
IDFC Nifty Fund Growth11.72%14.85%12.58%
ICICI Pru Nifty Index Fund17.34%11.48%15.80%
SBI Nifty Index Fund17.87%11.72%15.28%
Aditya Birla Sun Life Index Fund Growth10.82%13.64%11.57%

FAQs on Index Funds

Are index funds safe?

BSE Index has over 500 companies listed and over 200 mutual funds schemes and for an investor picking up the right investment is a daunting and tough task. All mutual funds are trying their best to achieve returns which are better than the index performance and achieving this is not possible always, especially in the long run. An index is an ideal investment choice for an investor who doesn’t have much knowledge of the financial market. The expense ratio of the index fund is very less as it is passively managed and does not require a team of an analysts to manage it. This ensures a good return in the long run and makes it a safe bet for an investor.

Can you lose money in an index fund?

Index funds imitate the portfolio of an index. The returns are based on underlying stocks which are part of the index. Hence, if the performance of the stock listed on the Sensex is bad, it will directly reflect on index funds performance. However, the benefit of index funds is an average of 30, 50 or 100 stocks as per the Indices and hence, the volatility factor is low compared to stocks. Therefore, the chances of losing money can happen only if the investor invests for a short period. It has been observed that if the investor invests for long terms like 5 years or more, the chances of occurring losses are very low.

How do I invest in index funds?

Investing in index funds can be done through online platforms today, without the need for paper documentation. It is easy and convenient and can be done by sitting at the comfort of your home. The KYC verification can also be done online through Aadhaar card and PAN card.

How much does it cost to invest in an index fund?

The expense ratio of index funds is normally around 0.5% as compared to actively managed funds that have an expense ratio between 1% to 2.5%. The reason behind the low expense ratio is that the portfolio of the index fund is passively managed and the fund manager does not need to make any investment strategy. Hence, investing in an index fund is cost-effective and this also results in better returns for the investor.

What are the advantages of investing in an index fund?

The advantages/benefits of investing in an index fund by an investor are:

  • Risk factor is low
  • Low expenses ratio
  • Consistent returns

What are the best ETFs to invest in 2019?

The best ETFs to invest in 2019 are as below -

  • UTI Nifty ETF INR (4 Start)
  • Edelweiss ETF – Nifty 50 (4 Start)
  • UTI Sensex ETF INR (4 Start)
  • Reliance ETF Sensex (4 Start)
  • SBI ETF BSE 100 ETF (4 Start)

What is an example of an index fund?

Most index funds track the benchmark indices Sensex and Nifty in India. The Nifty Next 50 is also a popular index. It is an index of the 50 major stocks that follow the Nifty 50 stocks. The Nifty Value 20 (NV) Index is another well-known index for trackers.

What is an index fund and how does it work?

An Index Fund is a mutual fund which puts investment in a market index such as the Sensex or Nifty 50. The fund invests in index stocks, in the proportion in which they are present in the index. It thus seeks to mirror the performance of an index.

What is best index fund to invest in?

Below are some of the best index funds to invest in the current year.

  1. UTI Nifty Index Fund Regular Growth
  2. HDFC Index Nifty 50
  3. SBI Nifty Index Fund.
  4. ICICI Prudential Nifty Next 50
  5. Franklin India Index Fund NSE Nifty Plan Growth

What is the average return of an index fund?

Any fund experiences a lot of volatility during the short-run which averages out in the long-run period, say, more than 5 years in order to give returns in the range of 10% to 12%.

What is the difference between a mutual fund and an index fund?

Index funds are a subset of mutual funds. A mutual fund pools money from different investors and invests it together using a certain strategic financial return goal. On the other hand, index fund is a mutual fund whose strategy is to mirror an index like NSE Nifty or BSE Sensex.