Index Funds

Diversification may be a key element of an honest investment

portfolio. Investors attempt to spread their funds across

various asset classes like equity, debt, land , gold, etc. Even

within each asset class, they struggle to further diversify to

attenuate risks. In equity investing, a known method of

reducing risks is diversifying your equity portfolio by investing

in shares of companies from different sectors and of market

capitalizations. this is often where the Index Funds step in.

Here, we'll explore Index Funds and mention the various sorts

of index funds in India along side their benefits and tons more.

1.What are Index Funds?

2.How do Index Funds work?

3.Who should invest in an Index Fund?

4.Factors to think about before investing in Index Funds in India

What are Index Funds?

As the name suggests, an Index open-end fund invests in stocks that imitate a stock exchange index just like the NSE Nifty, BSE Sensex, etc. These are passively managed funds which suggests that the fund manager invests within the same securities as present within the underlying index within the same proportion and doesn’t change the portfolio composition. These funds endeavor to supply returns like the index that they track.

How do Index Funds work?

Let’s say that an mutual fund is tracking the NSE Nifty Index. This fund will, therefore, have 50 stocks in its portfolio in similar proportions. An index can include equity and equity-related instruments along side bonds. The mutual fund ensures that it invests altogether the securities that the index tracks.

While an actively managed open-end fund endeavors to outperform its underlying benchmark, an mutual fund , being passively managed, tries to match the returns offered by the underlying index.

Who should invest in an Index Fund?

Since Index Funds track a market index, the returns are approximately almost like those offered by the index. Hence, investors preferring predictable returns and need to take a position within the equity markets without taking tons of risks prefer these funds. In an actively managed fund, the fund manager changes the composition of the portfolio supported his assessment of the possible performance of the underlying securities. This adds a component of risk to the portfolio. Since index funds are passively managed, such risks don't arise. However, the returns won't be far greater than those offered by the index. For investors seeking higher returns, actively managed equity funds are a far better option.

Factors to think about before investing in Index Funds in India

Here are some important aspects that you simply must consider before investing in index funds in India:

Risks and Returns

Since index funds track a market index and are passively managed, they're less volatile than the actively managed equity funds. Hence, the risks are lower. During a market rally, index funds returns are good usually. However, it's usually recommended to modify your investments to actively managed equity funds during a market slump. Ideally, you ought to have a healthy mixture of index funds and actively managed funds in your equity portfolio. Further, since the index funds endeavor to duplicate the performance of the index, returns are almost like those of the index. However, one component that needs your attention is Tracking Error. Therefore, before investing in an mutual fund , you want to search for one with rock bottom tracking error.

Expense Ratio

Expense Ratio may be a small percentage of the entire assets of the fund charged by the fund house towards fund management services. one among the most important USP of an mutual fund is its low expense ratio. Since the fund is passively managed, there's no got to create an investment strategy or research and find stocks for investing. This brings the fund management costs down resulting in a lower expense ratio.

Invest consistent with your Investment Plan

Index funds are recommended to investors with an investment horizon of seven years or more. it's been observed that these funds experience fluctuations within the short-term but it averages out over a extended term. With an investment window of a minimum of seven years, you'll expect to earn returns within the range of 10-12%. you'll align your long-term investment goals with these investments and stay invested for as long as you'll .

Tax

Being equity funds, index funds are subject to dividend distribution tax and capital gains tax subject to dividend distribution tax and capital gains tax.

Dividend Distribution Tax (DDT)

When a fund house pays dividends, a DDT of 10% is deducted at source before making the payment.

Capital Gains Tax

The capital gains earned by you for a holding period of up to at least one year = Short Term financial gain (STCG) which is taxed at 15%.

The capital gains earned by you for a holding period of quite one year = future financial gain (LTCG). LTCG up to Rs. 1 lakh isn't taxable. Any LTCG above this amount is taxed at the speed of 10% without indexation benefits

Here's What No One Tells You About Index Fund