Index mutual funds follow a similar investment strategy. Let’s take a look index funds How they work, their features and benefits, and factors to consider before investing.
What are Index Mutual Funds?
One
index mutual fund is an open-ended scheme that invests the majority of its investible corpus in underlying securities that comprise a benchmark, such as nifty 50 or Sensex 100. These funds invest a minimum of 95 per cent of their total assets in equities and equity related instruments of companies listed under a particular index without changing the composition. Since these are passively managed funds, the portfolio manager ensures that the structure of the index fund remains aligned with the securities in the underlying index. Unlike other mutual funds, which aim to outperform their benchmarks, index funds aim to generate returns closer to the underlying benchmark, rather than outperforming them.
Understanding How Index Mutual Funds Work
Let us assume that a particular index fund is tracking CNX Nifty (Nifty 50) as its underlying benchmark. Such an index fund portfolio would include all 50 stocks in the index in the same proportion as they are listed in the index. An index may consist of equities and equity-related instruments, or may also include: fixed income securities. Such an index is known as a fixed income index of a bond index. When it comes to active funds, fund managers actively manage the fund’s portfolio and are the decision makers. They are there to ensure that the fund beats the benchmark and generates returns that will outperform the competition. But in the case of passively managed funds such as index funds, they do not try to outperform their underlying index. rather than,
index funds Follow a passive investing style and are designed to closely track your benchmark and generate equitable returns. However, the returns generated by index funds are subject to tracking errors.
Index mutual funds are ideal for
When investing in mutual funds, investors must first identify the risks associated with the scheme, then determine whether their risk appetite allows them to take such risks. Also, it is important to ensure that the investment objective of the scheme aligns with that of the investor. Index funds that include stocks as their underlying securities carry a very high investment risk. Investors can also look at the riskometer to understand the volatility factor.
Investors who have a high risk appetite and are willing to invest for the long term can consider adding index funds to their mutual fund portfolio. Sometimes, investors are not comfortable with the fact that the returns generated by a mutual fund scheme are driven by human emotions.
They are not happy with the fact that fund managers can change the portfolio structure without their knowledge, and they may invest in stocks that are too volatile for their portfolio. This cannot happen with index funds because they only contain stocks that are listed on the underlying index. If the composition of the stock changes in the index change, the fund manager only rejigs to ensure that the portfolio matches the index structure to avoid tracking errors. Investors who are unwilling to invest in mutual funds that try to outperform the benchmark and who are okay with a plan trying to generate returns similar to their benchmark, may prefer index funds.
Things you should keep in mind before investing in Index Mutual Funds
Before investing in index mutual funds, investors should ensure that they have a long-term investment horizon. To allow equity linked schemes like index funds to perform to their full potential, investors are advised to stay invested for a long period of time. Short-term investments in equity-oriented index funds may not be advisable as equity investments are constantly affected by market volatility and may also generate negative returns in the short term. To see their investments grow slowly and compound, investors need to be patient and stay invested in index funds keeping in mind the long-term investment horizon.
since
index funds More likely to perform over the long term, investors can target their life’s long-term financial goals with index funds. If wealth creation is on your mind, index funds can give your portfolio the much-needed push. Index funds can also be considered for goals such as retirement planning. Index funds are known for having high risk-return tradeoffs. Though there is a lot of investment risk involved, there is a possibility that the scheme may allow investors to earn some capital growth over a long period of time.
As mentioned earlier, index funds are designed to map the performance of the index. This mostly excludes biases, errors or any investment risk that may be driven by human emotions. Index funds can allow investors to help with their financial goals, but investors are expected to diversify their portfolios with other actively managed mutual funds. It may not be advisable to rely solely on index funds to achieve all financial goals. Finding the right balance between active and passive funds can help investors build a rewarding portfolio.
Returns generated by index funds are based on the passive tracking style and are subject to tracking errors. The returns generated by an index fund may differ from the benchmark. If the index fund has many tracking errors, the actual returns are bound to deviate from the benchmark. Therefore, it is advisable to consider index funds, which have a low tracking error record. An index fund that is low on tracking errors may be able to generate returns close to its underlying benchmark.
When we talk about index mutual fund investing, it is impossible to exclude expense ratios from the discussion. Unlike actively managed funds, which have significantly higher expense ratios, index funds are considered a cost-effective investment. The returns generated by index funds are through a passive investment strategy. The fund manager is not required to design an investment strategy for the fund to generate returns. Index funds track their underlying benchmark and try to generate similar returns. Since there is not much participation from management, index mutual funds tend to attract low expense ratios. Realize that if two index funds are tracking the same index as their benchmark, they are probably going to generate similar returns. Hence, in such a scenario one can consider index funds with low expense ratios.
What are the Different Ways to Invest in Index Mutual Funds?
Like most mutual fund schemes, an individual can invest in index mutual funds either by investing as a lump sum or can consider opting for a systematic investment plan. Lump sum investment is something that the investor does right at the beginning of the investment cycle. This is the entire investment amount that he wants to invest in an index fund for potential capital appreciation. Lump sum investment can be in favor of those who have surplus capital sitting idle or for someone who has recently inherited wealth through his family or an old investment policy which has matured. It can also be favorable for those who have seasonal revenue and whose income is not regular. On the other hand, salaried individuals who have a source of regular monthly income can consider taking the SIP route.
Also, known as Systematic Investment Plan, SIP is probably the easiest and hassle-free way to invest in index funds. One needs to complete all the pre-investment formalities, make sure they are KYC compliant so that they can start their investment journey. Investing in index funds through SIP is a simple process. Investors need to decide on an amount that they want to invest from time to time. SIPs come in different forms – weekly, monthly, quarterly, biennially and annually. However, most of the individuals prefer monthly SIP option as in this way they save and invest a fixed amount every month. Once the individual decides the amount, decides the SIP date, and automates the transaction, every month after the specified date the predetermined SIP amount is debited from the investor’s savings account and the unit with the investor amount can buy. Unit allocation is done with the SIP amount and the current NAV (Net Asset Value) of the fund.
Here is an example of how you can invest in index funds through Axis Mutual Fund website –
- log onto www.axismf.com
- If you are switching to Axis Mutual Fund for the first time, click on the ‘New Investor’ icon to create an account
- Then, hover over the ‘All Schemes’ tab and when you find the dropdown, click on ‘Equity’.
- Let’s say you want to invest in Axis Nifty 100 Index Fund Regular Growth.
- Scroll down and search for ‘Axis Nifty 100 Index Fund Regular Growth’ and click on Scheme
- Click on ‘Start a SIP’
- Enter SIP amount, SIP date, SIP tenure and plan (growth/dividend)
You have just made your first investment in index mutual funds!
Investors must consult their financial advisor before investing in any type of mutual fund scheme. They should be fully aware of all the risks that are associated with the investments they make. Also, it is necessary to understand that the past returns of a mutual fund scheme may not be sustained in the future. Returns from mutual fund investments are subject to market risks and are never guaranteed.
Mutual fund investments are subject to market risks, read all the documents related to the scheme carefully.