Whether you are a matured investor or a beginner, index funds might be a suitable investment option for you. But before you invest in these funds, take a look at what index funds are and their benefits. So without further ado, let us first understand what an index fund is.
What are Index Funds?
Index funds are mutual fund schemes, which invest in asset classes like equities and debt. These are passive investment tools that mimic or track indices. For example, an index fund, which replicates the Nifty 50 index, will comprise of stocks from this index.
Simply put, an index fund aims to track the performance and returns of its benchmark or underlying index. This means there is no need for active management. The fund manager doesn’t have to analyse the markets and companies to choose individual securities. The portfolio also isn’t churned frequently. The stocks or assets in an index fund are usually rebalanced semi-annually, keeping in line with the changes in the underlying index.
Now let’s take a look at five reasons why investing in an index fund might be advantageous for you.
5 Reasons Why You Should Invest In An Index Fund
- Low Management Costs
As index funds replicate indices, the management fees are low. A fund manager doesn’t need to analyse stocks and trends to create a portfolio. A lower churn in the portfolio also means that transaction fees (costs of buying and selling stocks) are relatively lower. This is why index funds tend to have a lower expense ratio as compared to actively managed funds.
In comparison, in an actively managed fund, a fund manager and his research team have to thoroughly study the companies and trends. Hence, the management fees tend to be higher. Also, because of active stock picking, transaction costs can also be higher.
- Broad Diversification
Index funds offer diversification. For instance, an index fund which tracks the Nifty100 index will invest in 100 different stocks. A diverse portfolio means that even if one or more stocks witness a massive drop, the fund still has plenty of other stocks to make up for the loss. The stocks or companies from the indices are from different sectors and it is less likely that all those sectors will experience unfavourable conditions at the same time. This diversification lowers the risk of the overall portfolio or fund.
- Robust Returns
The index funds have the potential of offering robust returns over the long term. This is because the stock markets are expected to create wealth over the long term. Also, index funds could even outperform actively managed funds. This is because index funds are cost-efficient and eliminate the role of human bias.
- Reducing Human Errors
We know that index funds imitate the benchmark indexes. This means fund managers don’t have to select stocks or assets by conducting research. It eliminates the issue of human intervention or bias.
- Simple and transparent
When investing in an index fund, you are not investing in one single company. It means that you do not have to examine or study the finances and management of a company. You can merely track the performance of the underlying index. This also ensures there is transparency. Basically, investors can see how their money is being invested and whether the fund is generating the same returns as the index.