Every investor perfectly understands how beneficial it is to diversify their investments into different assets. For this purpose, index funds turn out to be the best mutual funds option out there. An index fund allows the investors to make an investment in a wider market index like the Nifty 50 & the Sensex. All these assets in these funds are represented in the form of indices, along with the amount/percentage of each stock. Therefore, it becomes easy to track the performance of stocks & reproduce it at very low cost.
How Do These Work?
These funds come under the passive fund management category because these are used to track a specific index of stocks or assets. In Active Funds Management, the main goal is to look for opportunities to buy or sell shares beyond the set benchmark. But in the case of an index fund, the goal is to become equal to the set benchmark. Thus, the selling & buying of the stocks is completely dependent upon the composition of the set benchmark. This is why the returns offered by these funds are almost equal to the target.
Although, it has been noted many times that the returns are not equal to the expected target. This type of situation is called ‘the tracking error' and the fund manager works as hard as possible to avoid such errors.
Who Must Invest In These Funds?
Every investment depends upon two main factors i.e. Risk Tolerance & Goal of the investment. The index funds are an excellent investment option for investors who like low risks and expected returns. No active management is required for these funds as tracking is easy due to indices. Thus, if you want to invest in equities but avoid the risk factors, the Nifty index fund is the best choice for you.
The returns offered by these funds are moderate and thus, these are not for investors looking for very high returns. An index fund offers good returns in a short period, but actively managed funds are a better option for a longer period.
Important Factor To Consider Before Investing
• Risk Factor - The risk involved in these funds is quite lower as compared to actively managed funds like equities. This is because of the indices being tracked continuously to match the set targets.
• Returns – The returns offered by these funds are not as high as actively-managed funds, but are equal to the set targets. In case of a tracking error, the returns can be unequal to the set benchmark. Thus, it is advised to do research and find an index fund with the least tracking errors.
• Investment Ratio – These funds have the least amount of investment ratio i.e. 0.5% or less.
• Financial Goals & Taxes – These funds are the best option for investors looking for low risk & targeted returns. Also, these offer capital gains to investors, that are taxable.
This was everything that you need to know before investing in index mutual funds.