One of the most common investment schemes that people opt for in India is mutual fund plans. Mutual funds are a type of investment product that is known for pooling money from a group of investors. Once enough money has been pooled, they are used to purchase different securities. The securities invested in mutual funds include things like bonds, gold, stocks, and even money market instruments. But just selecting mutual funds isn’t enough. You even need to select the right type of mutual fund. One such type of mutual fund is an index fund.
What are index funds:
Index funds are known for being the variant of a mutual fund scheme that imitates the portfolio of a certain index. Also called index-tied or index-tracked mutual funds, the main aim of these passively managed funds is to both track and match the performance of a popular stock market index like BSE Sensex and NSE NIFTY 50.
The asset allocation followed in an index fund will be the same as that of its underlying index. This is the reason why the revenue earned from index funds is comparable with their underlying index. In an index mutual fund, an investor’s money is pooled with other investors. After the accumulation of enough wealth, the fund manager allocates them to indices such as stocks and bonds. Even though the fund manager may or may not choose to invest in every component of an index, the main aim here is to get an appropriate sample of every piece. This ensures that the index performance over time can be effectively tracked.
How do they work?
An index can be defined as a group of securities that are known for defining a particular market segment. As index mutual funds are known for tracking a specific index, they fall under the passive fund management category. In a passively managed fund, traded securities are heavily dependent on the underlying benchmark. Moreover, passively managed funds are known for not requiring a team of research analysts to carefully analyze market movements and pick the most-suited stock. In contrast to actively managed funds which are known for striving to time and beat the market, an index fund is designed in such a way that its performance matches that of its index. The returns on index funds are aligned to the underlying market index.
Are there any advantages of investing in index funds?
Here are the numerous benefits of investing in index funds:
Index funds are known for coming with tax benefits:
As mentioned earlier, mutual funds are passively managed and as the investments made here are passive, index mutual funds are known for frequently generating a low turnover for the investors. When a fund manager places very few trades in a year, it is referred to as low turnover. Fewer trades being placed result in fewer capital gains distributions being passed on to the unitholders.
They can be managed easily:
Another popular advantage of these type of mutual funds is that these funds can be managed easily as the portfolio manager does not have to worry about how the index stocks are performing in the market. All that a fund manager needs to do in these funds is to periodically rebalance the portfolio.
You don’t need to pay exorbitant fees:
In index funds, there is no requirement for a team of research analysts. Generally, analysts are the professionals that can help fund managers to pick the right stocks. Also, there is no active trading of stocks in these funds. Such factors result in the low managing cost of an index fund. If someone is looking for an option in which they don’t need to pay a huge fee, then, they don’t need to look further than index funds.
The stocks consisting of index mutual funds are known for belonging to well-established companies and hence, they are not affected much by the market fluctuations. This feature ensures that you can enjoy a stable income consistently.
