Investing in Index Fund is one of the easy and best methods to start with for beginners in stock investing. Statistics suggest that equity has generated higher returns than any other assets over the long term. However, it takes a lot of market research to pick the right stocks for investing.
An index fund is a mutual fund that tracks a market index. This way, you invest in a diverse portfolio of stocks instead of buying individual stocks. When you invest in an index fund, that amount is invested in all the companies that are tracked by that particular index, and the index fund mimics the performance of the underlying index.
This article explains why Investing in Index Fund is a smart and hassle-free way to invest in equity, especially for beginners.
Investing in Index Fund
Index funds Eliminates selection dilemma
Mutual funds offer a plethora of schemes, including large-cap, mid-cap, small-cap, multi-cap, and hybrid mutual funds, among various other categories. Each type of mutual fund has a different risk-return profile and one needs to understand the objective and structure of a mutual fund before investing in it, which can be quite overwhelming for beginners. This is where index funds come into the picture.
Index funds allow you to invest in equity without having to decide on the investment style, sector, and other aspects of a mutual fund. They invest in all of the securities included in the market benchmark at the same proportion.
There are two widely tracked indices in India, the NSE Nifty (nifty index fund) and the BSE Sensex. Similarly, there are S&P500 and NASDAQ indices in the US market. These indices give the investor a representational figure of the market and help them better understand the overall condition of the market. For example, the index fund which tracks Nifty invests in the securities that lie in the Nifty index, while the one that tracks Sensex invests in the securities that are in the Sensex.
General exposure to equities
All investors have different goals and risk appetites. If you are new to investing in stocks or have a low-risk appetite, you can use index funds to gain exposure to equities. Index funds can be thought of as a reflection of the market. Since they mimic the portfolio of broad-based indices, their returns align with that of the market.
This is to say that if the Nifty rises or falls by 5% in a year, an index fund that tracks the Nifty will also rise or fall the same way with a minor tracking error. Thus, if you don’t have the time or resources to track different stocks or mutual funds, then investing in index funds is the way to go.
Diversification of portfolio
There is no doubt that a diverse investment portfolio is also the most sustainable as it helps you manage your risks. An index fund provides a simple solution to anyone looking to diversify their investment portfolio. If the index funds you choose are diversified enough, you can have a well-diversified portfolio just by investing in one or two index funds.
Consider an index fund that tracks the Nifty 50. This index holds the shares of 50 different stocks of 13 sectors ranging from financial to pharma services. Even though the performance of each of these 50 stocks will fluctuate with time, diversifying your portfolio will ensure that your returns are not directly correlated by any one of the companies, which is what happens in the case of stocks. In other words, there is comparatively less risk involved in index funds compared to other equity funds.
Moreover, index funds help overcome the bias of human discretion. This is because the index funds simply track the market, and eliminates the conditioning and past experiences of the fund managers, which can become a problem in other mutual funds.
Attractive returns at a low risk
In most cases, even the smartest portfolio managers can’t outperform index funds. Individual stocks may under perform or outperform the market, but, generally, the overall value of the stock market will appreciate with time. As a result, index funds give better risk-adjusted returns, making them an attractive instrument for any investor. Although there are better-performing actively-managed mutual funds compared to index funds, it will take a lot more time and effort at your end to find out the ones that outperform index funds. However, it is important to choose the best index funds to invest in.
Low investment costs and turnover ratio
Another benefit of investing in index funds is that the management fees, also known as the expense ratio, are lower in index funds compared to other mutual funds. Actively managed mutual funds are the mutual funds in which fund managers make investment decisions. The goal of active fund managers is to do better than the market.
The expense ratio in actively managed mutual funds can range anywhere between 1% to 2%. By contrast, index funds are passively managed mutual funds, meaning that they track the index by simply holding the stocks in that index. Since passively managed mutual funds require little input from the fund manager, the expense ratio is comparatively less and typically ranges from 0.02% to 1%.
Passively managed funds usually have a low turnover, meaning that fewer trades are placed by the fund manager for a given year. This implies fewer capital gains will be passed on to the investors, which also reduces the taxes on capital gains.
Index funds are a great way to start your investment journey. They can generate high and stable returns in the long run since both the Nifty and the Sensex have performed well previously.
Contrary to popular belief, you don’t need a sizable amount to start investing. The underlying concept of investing remains the same – the longer you stay invested, the better your returns could be. Therefore, you must invest regularly even if you can invest a small amount initially.
Index funds typically give a return of 10-12% annually. Those who wants to invest in index funds, Navi Nifty 50 Index Fund is a great option. This fund is free from fund manager bias and has a much lower expense ratio compared to other index funds on the market. This will also save your time to understand company insights to invest and reduce your risk exposure in the market.
With so many online investment platforms, investing has become easier than ever. All you need to do is to open a brokerage account, choose the right index fund for you, and watch your money grow.
More Across from our Website
We endeavor to help you to understand different aspects of a company before you invest in the company’s IPO. Learn all company insights to invest in new companies in the Indian share market 2023. To know more information about business overview of companies for investment, here are some suggested readings on company insights 10 Best IPOs in 2022, Concord Bio IPO, Tata Play IPO, Upcoming IPOs, Upcoming SME IPOs.