What are index funds & how to invest in them?
Index funds are essentially equity funds that mirror a particular index, like the Sensex or the Nifty.
What’s an index?
An index is a specific group of securities which define a particular market segment. So, if your index fund tracks the Nifty, it will have shares from all the 50 Nifty stocks in the same ratio. In theory, this means the fund will perform exactly as the index does. So, when you buy an index fund, you are getting a fairly well rounded choice of several stocks without having to purchase them individually. And because index funds are not actively managed, with a fund manager deciding on which stocks to buy or sell based on the underlying benchmark, they tend to have far lower operational costs and fees, giving you the benefit of a low expense ratio.
Stability, not performance:
Index funds don’t outperform the market, they strive instead for stability, thus adding some balance to your portfolio. Unlike actively managed funds, index funds track the performance of the underlying benchmark passively. However, the returns might not always reflect the actual performance of the index due to tracking errors, which can sometimes cause unexpected deviations. Tracking error is the difference between the return of a fund and its corresponding benchmark. Look for funds that have the least tracking error, since they are most likely to perform as expected.
If you are a novice investor, index funds are a great way to start. So, for instance, you want to buy equities but worry about the volatility of the equity market, you can opt for a Nifty or Sensex index fund. This will not give you the high returns associated with actively managed fund, but it also significantly pares down your risk. Since these funds are mapped against an index, they are less susceptible to short term market volatility. Because they are low-risk, you will not make the large gains that maybe possible from high-risk individual stocks.
Long term view:
Index funds are ideal for investors who are risk-averse and expect predictable returns over a long-term horizon. Index funds may undergo several fluctuations during the short-run, but this averages out in the long term, to deliver good returns. It is thus extremely important to invest funds that you can spare for longer periods in order to really profit from index funds. Before you zero in on a particular index, please undertake due diligence to ensure that it aligns with your risk appetite, financial goals and investment horizon.
How to invest:
Investing in index funds is easy. You can either invest directly by visiting the website or the branch of the specific fund you want to invest in or through a registered mutual fund distributor.
Disclaimer: ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. AMFI Regn. No.: ARN-0845. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon.