Should I Invest in Index Funds in India | Fusion - WeRIndia

Should I Invest in Index Funds in India

Should I Invest in Index Funds in India

Index funds are more suited for conservative equity investors. However this will not solve your doubt as we need to understand what index funds are, how do they work, why is it more suited for conservative investors and should you invest in it. It is always better to make an informed decision so do spare some time to understand what these funds are too.

What are index funds?

Index funds are mutual funds that imitate a stock index completely. Other mutual funds like equity mutual funds and debt mutual funds use the money held by them to invest in stocks and bonds and their holdings can change and as and when the fund manager deems necessary but in the case  of index funds, the money held by the funds is used to copy the stock index’s movements. They are regulatorily bound to copy the stock index’s movements.

Say for example Axis Nifty 100 Index Fund. This index fund apes the movements of Nifty 100 index. If the index drops or adds any of its constituents or changes the weightage of any of the companies that are listed on the exchange, the fund manager of this index fund had to make the changes in the exact manner and proportions.

Therefore, index funds are funds that ape a stock index in terms of constituents, proportion of the constituents and ultimately the returns as well. There is a huge list of index funds. There can be around two index funds for a particular stock market index. Two because we have two primary stock exchanges.

What is the fund manager’s role and how do index funds work?

Here the pressure on the fund manager is much lesser as compared to other equity funds. There is no pressure to beat the benchmark. You have to directly  copy the movements of an index. The fund manager will have to be prompt with these changes so that the index fund reflects the returns of the stock index. This is the reason why the expense ratio of index funds is also low. In fact, Securities and Exchange Board of India (Sebi) has said that the expense ratio of index funds cannot cross 1%. The example that we used of Axis Nifty 100 has an expense ratio of 0.19%.

Index funds are passive funds

Index funds are passively managed funds as there is no active involvement of the fund manager as we understood in the previous section. The fund manager cannot take his or her own decisions and is noun to imitate the index.

If index funds are the same as the index, why are the returns different at times?

If you look at the list of index funds, you might see that mostly the returns of an index fund is lesser than the actual returns of the market index.The reason is that the final returns that you get from your mutual funds investment, after you redeem it, will be reduced because of the charges that a mutual fund carries. Expense ratio, which is the charge you pay to the fund manager for his/her services and expertise, is one of the charges that you pay. Also, some mutual funds also carry an exit load wherein the mutual fund company will charge you a small percentage of your investment as a penalty for exiting the mutual fund. Very few mutual funds have exit loads these days. Therefore, the returns of the best index funds in the market will be as close to the returns of the index as possible.

Risk and Returns of an index fund

Index funds do not beat the benchmark and do not generate the ‘alpha’. Alpha in mutual fund slang means the returns a fund generates. Index funds do carry the benefits of being an equity mutual fund so the returns are higher than a lot other traditional investment products. However if you look at an index fund and compare it with other peer categories such as lag cap funds, mid cap funds, small cap funds and so on and so forth, within the larger umbrella of equity funds, index funds generate much moderate returns as compared to other equity funds.

Where the returns are moderate, the risk is moderate too. So an index fund will be much safer than a small-cap or mid cap fund and the returns will also be moderate.

Hence, the best index funds in India  will at the most have returns equal to that of the stock market index it is attached to.  The returns can be lesser but cannot be more than what the index is returning.

Should I invest in index funds in India?

Naturally an investor who is conservative, who does not want to risk it with his or her money but still wants to reap the benefits of an equity linked investment can look to invest in index funds. So if you think you fit into an investor profile that is cnservatuve, is risk averse and is satisfied with moderate returns but also does not want to be tied with the fixed returns of traditional products, index funds should be the best choice for you. So if you are a conservative equity investor and if you are wondering should you invest in index funds, then the answer is yes.

Image Credit:– “Index Funds Wall Street Sign” by Investment Zen is licensed under CC BY 2.0.

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