Understanding the Main Features & Benefits of Index Funds

Investing in index funds is a great way to diversify your investment portfolio. Read on to learn more about what is index fund and the key features of index funds, and their benefits.

BSE Sensex was hovering at around the 34,000 mark in February of 2018. Cut to 5 years later, and it’s touching 61,000 levels, a jump of around 78% in 5 years. This means if you had invested Rs 50 lakh 5 years back in the BSE Sensex stocks in the same proportion as its weightage on the index, your total worth of investment would have jumped to 89 lakhs today.

But what if there could actually be a way to mimic an index and invest in all the equities of a particular index?

Well, there is. Say hello to Index Funds. 

You can also be a part of this development and growth story by investing in index funds in India

Key Features of Index Funds

  • Passive Management

Index funds are passively managed, meaning they seek to replicate the performance of a particular market index rather than trying to outperform it through active management. Therefore, the fund manager has a lesser role in picking up the stocks in an index fund than in an active fund.

  • Low Fees

Index funds require less research and analysis with low involvement of fund managers. So, they typically have a lower expense ratio than actively managed funds.

Benefits of Index Funds

  • Simple to Understand and Compare

Since index funds strictly follow an underlying index, they have a simple portfolio mix that is easy to understand. It’s also easy to gauge their performance. All you need to do is compare the returns of an index fund to that of its benchmark index.

  • Diversification

Index funds provide broad market exposure across different market capitalisations and sectors. This helps to diversify investment risk across multiple companies and sectors.

  • Good Performance History

Market indices have performed well over the past many years. For instance, the Nifty 50 has increased manyfold in the last 28 years since its base in the year 1995. So, if an investor had stayed invested in an index fund tracking the Nifty 50 for all these years, the returns would be quite good. 

As the economy grows further, market indices may continue their stellar run in the upcoming years as well. Consequently, index funds in India can also replicate the success of their benchmark index in the future.

While these indices go through their ups and downs in the short run, it is evident that the graph has been rising in the long run. 

  • Transparency

Well-known market indices like Nifty 50, Bank Nifty, etc., are widely tracked. Index funds tracking these indices are generally transparent in their holdings and investment strategy. 

  • Overcoming Human Bias

Human decisions can influence actively managed funds. The fund manager’s personal predispositions, biases, and previous encounters may impact the fund’s investment approach or stock picks. On the other hand, index funds typically mitigate the influence of human bias to a great extent as they strictly follow the composition of the benchmark index.

  • Greater Probability of Having Quality Stocks

Stock indices periodically review the performance of all stocks that are part of them. So, the process of replacing underperforming stocks with better ones continuously takes place. Index funds also make similar modifications to reflect the changes in their underlying benchmark. Therefore, you will likely be invested in quality stocks through index funds.

If you’re someone who believes in the future growth of market indices and minimal human interference in your mutual fund, look no further than index funds. While these funds carry inherent risks typical to mutual funds, investing in them for a long period, say 5-10 years, can bring you heavy rewards. 

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