Passively controlled products had witnessed a tremendous increase in popularity when the market was reeling from the impact of the Covid-19 outbreak. Passive investments, including anything from index funds to exchange-traded funds (ETFs), have grown in popularity in terms of assets under management and investor interest.
According to the Association of Mutual Funds in India, Index funds’ average AUM has nearly tripled to Rs 240 billion since January 2020. ETFs, including gold ETFs, have increased by 1.7 times to Rs 3 trillion.
The index investing strategy is building portfolios based on a stock index, benchmark, or market average. Still, most fund managers fail to outperform the market. The concept is that tracking an index, such as the S&P 500 Index, while avoiding costs and fees is the best approach to investing in a diverse portfolio.
Although index fund investment and passive investing are often used interchangeably, there are a few reasons why some investors believe the average investor should avoid index funds entirely.
What are Index Funds?
A broad market exposure, low operating expenses, and low portfolio turnover are all claimed benefits of an index mutual fund. It is clear that managed capitals provide superior diversification than many direct stock investments. There are hundreds of such funds available, divided into two categories: active and passive funds. Actively managed funds use clever share selection to outperform the benchmark index.
How do Index Funds work?
An index fund is a diversified equities fund with a twist: no fund manager is involved in-stock selection. An index fund’s portfolio, both in terms of stock selection and percentage ownership, is always identical to that of an index.
Thus, an index fund’s NAV moves almost in lockstep with the index it tracks in this relationship. For example, if the index (say, the Sensex) climbs 10% in a month, the NAV of a Sensex-linked index fund will rise 10% during the same time. The index fund’s NAV will drop 10% if the Sensex falls 10%.
Advantages of having a having Index in an investment plan
Index funds’ most obvious benefit is that they quickly diversify your portfolio, lowering the risk of losing some or all of your money.
Take the Nifty 50 index as an example. Using this index, an investor can gain access to more than 40 distinct companies. As a result, the value of one’s portfolio will not be negatively impacted if the index’s companies perform poorly. Furthermore, each ticket for this variety costs as little as Rs 100.
The costs of investing in an index fund are often relatively modest. According to market regulator SEBI, the total expense ratio for an index fund is restricted to 1%. For an investor familiar with index fund investing, this turns out to be a cheaper option when compared to actively managed counterparts.
When data from index funds is examined, it becomes evident that these products provide consistent returns year after year. These funds have outperformed their peers in other categories on occasion, and a return like that could give good gain for some long-term investors.
Picking specific stocks for investing can be difficult at times, so index funds may be the best option for you. These funds may provide a consistent return without requiring you to manage individual companies and funds in your portfolio actively.
Index funds should be an element of any investor’s asset allocation. Index funds can also be used as a necessary step into equities by first-time investors. Returns may be erratic in the short term, but over time, the variations will even out. To summarize, an index fund is one of the most cost-effective ways to gain exposure to stock markets, but before investing, make sure the fund suits your investment horizon, risk appetite, and financial aim.