Index Fund: Better LumpSum Investment Option
What is Index Fund?
How Index Funds work?
Who can invest in index funds?
Risk and Rewards?
Index Fund: An Idea
The idea of index funds started in around the 1970s. It has been grabbing the attention of everybody because of low prices, passive investing, very low expense ratios, etc. Index funds are a special type of mutual fund which comes under a Passive Mutual fund category. As the name suggests, an Index fund invests in the market index or we can say indices of NSE and BSE.
E.g.,
An index fund will exactly invest in the stocks which form a constituent of NSE Nifty or BSE Sensex and other various indices NSE and BSE.
So, the fund managers need not require to do the research, etc.
They will just follow stocks that are there in market indices. So there are various benefits that I will cover in the next sections of the blog.
The bottom line is that these funds invest in the same securities or stocks as present in the underlying index in the same proportion and doesn’t change the portfolio structure.
How it works?
Instead of doing the research and picking up the stock by timing the market, the fund managers of the Index funds will mirror the stocks/shares of a particular index of an exchange. However, the particular index fund will follow the same returns as that of the market index from which it is copied.
Let's consider this with the below example:
We all know that on 23rd March 2020, Sensex and Nifty were down to 25981 and 7610 respectively. It was a dark day for some people in the share market...
But indeed it was the best day for the long term investors who invested on that day.
Let's say Mr. X invested 1 lakh rupees on that day in the Nifty index fund and 1 lakh in the Sensex index fund of XYZ fund house.
So now today as on 11th September 2020, Nifty stands at 11464 and Sensex stands at 38854.
So, let us calculate the return as of today for Mr. X's investment.
From 23rd March to 11th September, Sensex has grown 49.5%, and Nifty by 50.6%.
So,
Mr. X's Nifty index fund will give 49.5% return; i.e, today's value 149500
Mr. X's Sensex index fund will give 50.6% return; i.e, today's value 150600
However, this is a staggering return in less than 6 months.
Who should invest?
Although everybody can invest in the Index funds, one should decide on whether to invest or not basis their risk capability, funds risk-reward ratio, etc.
Since index funds are passive funds there is very little risk.
A person who doesn't know in which mutual funds he/she should invest or a person who doesn't want to take too much risk with his/her money can go for the index fund. As the only one strategy of an index fund is just to imitate the market indices investors, who prefer predictable returns prefer these funds.
For investors endeavoring higher returns, actively managed equity funds are a better option.
Risk, Rewards, Advantages:
Index funds work very effectively, during the market rally as shown and explained in the above example. As these funds follow the market index, the risks are lower. The low expense ratio due to passiveness makes it a big hit for the long term. These funds are less volatile than the actively managed equity funds.
As the market indices are very well diverse, index funds offer good diversification.
Sometimes these funds outperform the actively managed mutual funds as well.
Below are the top-performing index funds.
- TATA Index Sensex Fund.
- HDFC Index Sensex Fund
- Nippon India Index Sensex
- IDFC Nifty Fund
- UTI Nifty Index Fund
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