Index Funds Might Be a Better Choice for the New Investor

Index Funds Might Be a Better Choice for the New Investor

In India, inflow of domestic investors money in equity (Mutual Fund) has been increasing significantly over the past few decades.

For those still in woods, a mutual fund is a professionally managed investment scheme run by an asset management firm that accumulates people’s money and invest them in stocks, bonds and other securities.

You can start investing a little as much as with Rs 500 from a mutual fund, a simple Google search would through up numerous  large cap equity fund options.

But unfortunately, for many first- time investors, having to choose from the plethora of equity funds, all claiming their best performance in its category, is like finding a needle out from what seems like a stack of schemes available.

So, for those investors who want to take advantage of equity in the long term, but after looking same types of schemes, they have become confused, Index Fund is a great option for them.

Index funds, as its name implies, put money into an index. same stocks are purchased by these funds in the same weightage as it is in index. This usually means these funds will imitate the performance of index it is tracking.

Well, it’s correct that the fund manager in an active fund attempts to earn extra returns over the benchmark index. However, many reports abroad have proven it is impossible to beat the benchmark index year on year.

Warren Buffett in one interview stated that investors may make excellent yields by investing in index funds, that are passive investing. Citing the instance of Vanguard index funds which track the S&P 500 index of big American businesses.

Buffett stated that passive income or unmanaged funds may do better or provide great returns than hyperactive or actively managed funds that are managed by fund manager that charge hefty fees to handle it.

It is an incontrovertible fact that the cost for investment is an important part of a return, if your cost is high, then your return will probably be dilluted to that extent, Index funds charge very less fund management fess as comapred to Actively managed funds.

cost of any funds is a significant aspect to consider while making any investment. In actively managed fund, management fee may go up to 2.5%-3%. But in Index fund usually, we will need to give 0.2% to 1%.

For example, In SBI Nifty Index fund has an expense ratio of 0.27%(in Direct Plan) whereas, in same fund House SBI BLUECHIP has an expense ratio of 1.13%.  In UTI Nifty Index fund, have an expense ratio of 0.13%.

The biggest advantage of the index fund is low cost as compared to actively managed funds. The expense ratio of most of the index fund would be less than 1%, and another advantage is low volatility.

While in Active manage funds might be that it could generate better returns over the benchmark with 3-5% margin, but in the downturn, it might fall by the same margin. Index funds are suitable for those investors who want to prevent volatility in their investments.

One more factor to think about while investing in Index funds is Tracking error, which is only the difference between the returns of the index fund and the benchmark index.

Tracking error occurs when the fund is not able to match the index movements. Say, there is an open-ended fund which monitors Nifty also it goes up by 90 basis points, whereas Nifty itself goes up by 1 percent. The gap would lead to tracking error. You must always choose to those funds that have low tracking errors in their past performance.

A plethora of factors such as re-categorization of mutual funds, debut of Total Return Index or TRI as a benchmark, and so forth, have established an environment where a change towards index funds seems inevitable. 

 

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