Index funds are considered ideal core portfolio holdings by investors as a safer option for retirement. Many great investors suggest that index funds are one of the best options for retirement plans. It is a better option to pick up index funds instead of individual stocks because they offer a lot more at a very lower price.
But what are index funds? An index fund is a type of mutual fund or ETF including various individual stocks made to match or track the components of a financial market index. Index funds follow their benchmark index regardless of the state of the markets and also provide a broad market exposure, low operating expense, and low portfolio turnover
How do index funds work?
An index fund is a portfolio but with passive fund management meaning that it isn’t managed by a professional. Unlike mutual funds, In index funds, no one is strategizing on which stocks to buy and sell from the portfolio. Every financial market has index funds. SENSEX or NIFTY 50. S & P 500.
The Russell 2000 Index and the Wilshire 5000 Total Market Index are some examples of Index funds around the globe. An index fund tracking Dow Jones Industrial Average (DJIA) will be investing in the same large and publicly owned companies that are present in that index.
The portfolios of an index fund also change but only when the benchmark index changes. This means that if a fund has a particular weighted index, then there might be a rebalance of securities done by the managers to average out the weight of a particular holding in an index.
What are the advantages and disadvantages of an Index fund?
Key features of Index funds
Index funds have a very low expense ratio which is one of the primary advantages they possess. A fund’s expense ratio also known as the management expense ratio includes the various costs involved while operating a fund. These costs involve the payment to advisors and managers, the various transaction fees, taxes, etc.
The expense ratio is very less comparatively as there are no professionals involved in managing these funds. Therefore the cost for research analysts and the team constantly working on the stock selection process is not needed in this case. Since the managers involved in index funds don’t need to switch up the holdings very often, the transitions are less involved in lower fees.
However, the same is not the case with mutual funds where the expense ratio is more as the managers involved are constantly working on the mutual funds. These manpower costs are added to the expense ratio and passed on to the investors. Index funds have expense ratio costs of less than 1%—0.2% to 0.5% and even lower than 0.05% in some cases. Whereas for mutual funds this cost can go up to 2.5% as well.
Diversifying your portfolio among so many companies ensures that your portfolio’s value is not overly correlated with the fortunes of any one company listed in the index. Index funds offer broad diversification to investors. It has a portfolio that includes different stocks each contributing its performance and growth factor to the portfolio.
This diversification comes as an advantage to the investors as it helps them get less affected by the volatility in case any of the stocks take a dip. An investor can invest in more than one index fund to help its portfolio not be overly correlated with the stocks of any particular company in the index.
According to Standard & Poor’s research, only 23% of actively managed funds have beaten the S&P 500 over 5 years. Investing in a particular stock can be a risky bet as it can or cannot outperform the market but the market as a whole is only increasing over time. Therefore, investing in index funds is an attractive option for long-term investors to invest their money.
As the majority of mutual funds have not outperformed the index funds, it is quite safe to say that index funds are one of the best options to invest money with low risk and high returns in the long term. Whereas in terms of short-term periods, some mutual funds might perform better than the index funds.
How to buy index funds in India
An investor can start investing in index funds through brokerage firms. You can easily sign up on MoneyIsle to start investing in Index funds and get multi-layered security for all your transactions and keep a track of all your investments from a single platform.
Once you have opened your Demat account, you need to choose an index to invest in. In India, you have various options for index funds to invest in like Nippon India Index Fund – Sensex Plan, LIC MF Index Fund Sensex, ICICI Prudential Nifty Index Fund, and UTI Nifty Index Fund.
Before choosing an index fund to invest in, make sure you have done your research in choosing the right one. You might want to keep a check on the past performance of the fund, the expense ratio, and the companies included in the funds. For a new investor or an experienced one, index funds are always a great option to invest in. It might take some time for you to find the right index fund to invest in but it will be worth it in the long term.