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What are Index Funds?

What are Index Funds?

Let’s take a moment to recall Index funds, which we talked about in different types of mutual funds. This time, we shall focus primarily on these Index funds. We shall go through all the features of Index funds such as description, differences between index funds and non-index funds, should we invest in them or not and advantages.

Key Points:

  1. An Index fund can be termed as a copy, or mirror, of the market index. It moves in parallel with the market index.
  2. The primary advantage of Index funds is the lower management expense.
  3. On many occasions, index funds can beat actively-managed funds.

Let’s start with the description of Index mutual funds.

Index Mutual Funds

An Index fund can be termed as a copy, or mirror, of the market index. It moves in parallel with the market index. It pools its money from the investors and invests them in a portfolio which is exactly similar to a market index. The proportion of investments is also exactly similar to the weight of the stocks in the index. Index funds provide an investor with market exposure, low operating expenses and low portfolio turnover. It is ideal for you if you are not confident or not comfortable in taking a risk in the equity market. Index funds can provide you stability.

Differences between index funds and non-index funds

The primary advantage of index funds is the lower management expense. Your index funds are not managed by a highly-expert money manager, since there isn’t any strategy to formulate and execute. The funds simply replicate the markets’ performance. The fund managers of your Index funds just duplicate the index, and do not have to go through the trouble of analysing individual stocks and keeping a track of the portfolio from time to time.

Should you invest in debt funds?

As recently as 2016, actively managed mutual funds were unable to beat index funds. Indian markets continue to rise, and the indices are growing accordingly.

In India, you have 3 options when investing in index funds:

  1. The Nifty, which has 50 companies
  2. The Sensex, which has 30 companies
  3. Index plus funds which invest majorly in a particular index and rest are actively managed.

Advantages of Index Funds

We repeat. Don’t dismiss index funds outright. The benefits of an index fund are as follows:

  • Safer than non-index funds: Investors often fail to achieve good returns. If you invest in Index funds, you’re at least guaranteed a threshold average market returns.
  • Can outperform actively-managed funds: On many occasions, index funds can beat actively-managed funds, especially in booming economies.
  • Costs less: One of the most important reasons that non-index funds underperform compared to index funds is that they have a high running cost. Non-index funds are run by expert analysts which can increase the operating fees.
Wrapping Up

  • Index funds might be safer than non-index funds however they are not without risks so this might be a good option for investors who are risk averse.
  • Because index funds replicate their market indices they will perform well if the market as a whole performs well and vice versa.
  • You can invest in index funds just like you would in any other mutual fund. Once you open a demat account several brokers will offer you an online investing platform from where you can choose the type of mutual fund that suits you.