8 Jul, 2024
7 mins read
What is the cardinal truth of investing in stock markets? It is to go long. Stock markets, in the long run are known to yield the highest inflation-adjusted returns. So rather than going through the pain of picking individual stocks, why not invest in the indices as a whole? This is where index funds come into play. Index funds invest in a bunch of stocks based on the benchmark index. Learn all about index funds in this blog to know why they should be a definite addition to your investment portfolio.
Index funds are mutual funds that aim to replicate the performance of an index. This implies that the index funds' returns are directly dependent on the performance of the index that they track. These funds invest in a diversified portfolio of stocks in the same proportion or weightage as the index that they follow.
Index funds are classified under the passive investment category, and fund managers do not play an active role in strategically selecting stocks for the fund. However, index funds returns are affected by tracking errors and it is the job of the fund manager to reduce them effectively. Therefore, index funds offer a hassle-free cost-effective way to gain market exposure at lower risk. It is a convenient low-maintenance option for investors seeking long-term growth without the need to manage their portfolio actively.
Index funds, like any other mutual funds, pool the money from many investors to buy a portfolio of stocks that mirrors a specific market index. These funds invest in the same stocks and in the same proportions as the index they track. Unlike actively managed funds that aim to outperform their benchmark indices, index funds returns are closely matched to the index's performance. This passive investment strategy offers broad market exposure and diversification at lower costs compared to actively managed funds.
The steps to buy an index fund are similar to buying any other mutual funds. Here is a brief analysis of the process.
The next step is to open a demat account or a mutual fund account and complete the necessary KYC formalities.
The first step is to choose the index and the funds that follow the said index after thorough research of factors like historical performance, risk-return preference, fund manager history, tracking errors, fund house reputation, expense ratio, investment horizon, etc.
Select the mode of investment (SIP or Lumpsum) and add the number of units of the target fund to be bought.
Pay the amount for investment and monitor the portfolio regularly to adjust to meet necessary parameters.
Investors can choose index funds that suit their investment style or end goals. Here are a few types of index funds that investors can opt for.
Broad market index funds replicate an index representing the overall performance of a major stock market segment like Nifty 50 or Sensex. These funds offer broad market exposure by mirroring the returns of the entire market, helping investors diversify their portfolios across various sectors and companies. These funds aim to capture the economy's overall growth by investing in a wide array of top-performing companies, providing a reliable and straightforward investment option for long-term wealth accumulation. Some popular examples of broad market index funds in India include SBI Nifty Index Direct Plan, ICICI Prudential Nifty 50 Index Direct Plan, HDFC Index Fund - Nifty 50 Plan and LIC MF Nifty Next Index Fund Direct.
Market capitalisation index funds allocate weight to stocks based on their market capitalisation. These funds cater to different risk appetites and investment goals, allowing investors to choose between the stability of large-cap stocks and the potential for higher returns from small-cap stocks. A few popular examples of market capitalisation index funds include UTI Nifty 50 Index Fund, Motilal Oswal Nifty Midcap 150 Index Fund, Axis Nifty 100 Index Fund and ICICI Prudential Nifty Next 50 Index Fund.
Sector-based index funds track the performance of specific market sectors, such as technology, healthcare, or finance, allowing investors to capitalise on the growth potential of particular sectors or industries. Investors can choose sector-specific index funds based on their preferences and market outlook, enabling them to tailor their investment portfolios to align with specific economic trends and personal interests. Some top examples of sector-based index funds include ICICI Prudential Technology Fund, Aditya Birla Sun Life Banking & Financial Services Fund, Quant Infrastructure Fund and SBI Consumption Opportunities Fund.
International index funds invest in global market indices like the S&P 500 or MSCI World providing access to a diversified portfolio of global companies and exposure beyond the Indian stock market. These funds allow Indian investors to benefit from growth opportunities in developed and emerging markets worldwide and hedge against domestic market risks. The top names in this fund category include the Motilal Oswal S&P 500 Index Fund, Nippon India US Equity Opportunities Fund, Kotak Nasdaq 100 Fund of Fund, and ICICI Prudential US Bluechip Equity Fund Direct Growth.
Debt index funds invest in fixed-income securities such as government and corporate bonds. They track debt market indices and aim to offer stable returns at lower risk compared to equities, making them ideal for conservative investors or those seeking steady income. These funds are especially useful for individuals approaching retirement or those needing a more stable investment vehicle. A few examples of debt index funds are Aditya Birla Sun Life CRISIL IBX GILT APRIL 2033 Index Fund, Tata Nifty G-Sec Dec 2029 Index Fund and Axis CRISIL IBX SDL June 2034 Debt Index Fund.
Equal-weight index funds follow an index that allocates an equal weight to all stocks in the index. This approach contrasts traditional market-cap-weighted indices, which give larger companies more weight. Equal-weight index funds provide a balanced approach by ensuring that each stock contributes equally to the fund's performance. This strategy can reduce concentration risk and potentially enhance returns by giving smaller companies more influence, appealing to investors who prefer a more evenly distributed exposure within their portfolio. A few top examples of sector-based index funds include Sundaram Nifty 100 Equal Weight Fund and DSP Nifty 50 Equal Weight Index Fund.
Factor-based index funds or Smart Beta Index Funds construct their portfolios using specific factors, such as value, growth, dividend yield, PE ratio, etc. and offer a strategic investment approach. These funds aim to outperform traditional market-cap-weighted indices by focusing on stocks that exhibit certain desired characteristics. For example, a value factor index fund might invest in undervalued stocks, while a growth factor fund would target companies with strong earnings growth. Factor-based index funds seek to leverage academic and empirical research to achieve better risk-adjusted returns. Factors-based index funds in India include Bandhan Nifty100 Low Volatility 30 Index Fund, Nippon India Nifty 50 Value 20 Index Fund, and ICICI Prudential Nifty Alpha Low Volatility 30.
Index funds are a safer and easier way for investors to tap into the equity return’s potential at reduced risks and benefit from the overall market performance in the long term. They are ideal for beginners in stock markets with limited financial expertise or risk-averse investors to build a long-term investment portfolio by offering a dynamic yet stable approach to wealth creation.
Index funds are good investment options for investors as they offer diversified portfolios at low costs and the potential for steady, long-term growth at minimal risks, free from perils like fund manager bias.
Some examples of the top index funds in India are the UTI Nifty 50 Index Fund, HDFC Index Fund, ICICI Prudential Nifty 50 Index Fund, SBI Nifty Index Fund, HDFC Index Fund, and BSE Sensex Fund.
Index funds are ideal for beginners in stock markets, long-term investors, risk-averse investors, and passive investors looking to invest in mutual funds that provide stable returns at lower costs.
Calculate your Net P&L after deducting all the charges like Tax, Brokerage, etc.
Find your required margin.
Calculate the average price you paid for a stock and determine your total cost.
Estimate your investment growth. Calculate potential returns on one-time investments.
Forecast your investment returns. Understand potential growth with regular contributions.
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