Table of Contents
- About Index Funds
- Types of Index Funds
- International Index Funds
- Market Capitalization
- Bond based Index Funds
- Earning based Index Funds
- Invest Funds for long-term investment perspective
- Is Index Funds good to Invest:
1. About Index Funds
As the name suggests, “Index” an index mutual fund invests in stocks or shares that resemble a stock market index like, NSE nifty, BSE Sensex etc which are some of the popular indices in India. These funds passively monitor a specific index’s performance. That means the fund managers invest in the same securities as present in the index and don’t change the composition. In the long run index funds have performed way better than other types of mutual funds. You can purchase index funds through your brokerage account or directly from an index fund provider. Index funds provide you exposure to a number of securities or shares that helps you reduce the risks of investment through broader heterogeneity.
An index is a group of securities that define a market segment. These securities can be debt oriented schemes like bonds, or equity oriented instruments like stocks. Index funds offer returns more or less equal to the benchmark of that particular index that it follows. Since these are passively managed funds, the fund manager chooses which fund to be bought and sold according to the index that the fund is tracking. These funds are perfect for those investors who want to invest in equities but don’t have time to trace their performance. As these funds follow a particular index, the risk factor here is less as compared to the funds that are actively managed and are based on the assessment of the fund managers. There is a broad variety of index funds.
2. Types of Index Funds:
- International Index Funds:
Global Index funds provide you with exposure to international markets. You can invest in shares that are not confined to a particular region.
- Market Capitalization :
Investors with a long term investment can invest in a broad variety of medium and small sized enterprises, that take time to grow and generate decent returns. This can be achieved by market capitalization.
- Bond based Index Funds:
Investment in debt oriented schemes like bond index funds, can maintain a healthy investment portfolio as it comes with various investment tenures of short, medium and long terms and also generates a stable income source.
- Earning based Index Funds:
Index funds also work on the basis of earnings of a company. There are two types of indices associated with it. Growth index and Value index. Growth indices consist of companies that are expected to grow and generate profits quickly and value indices comprises stocks that are traded at a lower cost compared to the earnings of the companies.
3. Invest Funds for long-term investment perspective:
Since index funds replicate an index, they are less vulnerable to market fluctuations and other equity related risks. Index funds perform very well during market rise and tend to lose their value during a market downturn. Actively managed funds perform well during a market downslide. So, it is advised to have a blend of actively managed funds and index funds in your investment portfolio. As index funds replicate the performance of a particular index, the returns generated might not be equal to the index due to tracking errors. Hence it is advised to invest in funds with minimum tracking errors. Index funds have a lower expense ratio of 0.5% or even less. So the fund houses with lower expense ratio generate maximum returns. Index funds are basically best suited for investors with a long-term investment perspective, as these funds face fluctuations in the short run and are more likely to generate good returns in the long run, say more than seven years or so only. Hence these are for long term financial goals like retirement planning. The capital gains on these funds are taxable. The rate of taxation depends on the investment tenure. Short term capital gains are taxed at a rate of 15% and long term capital gains are taxed at over Rs. 1lakh at 10% without the benefit of indexation.
4. Is Index Funds good to Invest:
Though index funds are a popular investment option, there are also some reasons why investors avoid index funds. Index funds to provide best returns when the market is doing well, but also leave you completely prone during the slump. When a share is overvalued, it gains more weight in an index. Even if you know the valuation of the stock, if you go by the index, you will not be able to earn good returns. Investors have no control over the individual holdings in their investment portfolio if they buy an index fund. There are various investment strategies that provide better risk adjusted returns. But buying an index fund will not allow you to implement those strategies as it is passively managed.
Investing in an index fund can be very stressful and worrisome during a market slump. So most of the investors avoid investing in an index fund. Finally, index funds do provide an advantage to give you a broader economic view, but there are several other reasons that sometimes may not suit your personal financial goals.