When it comes to investing, there are myriad ways in which one can invest. As a beginner in the investing journey, it may not be an easy task to discern what could be the optimal way of investing, especially when it comes to the equity market.
Chintan Haria, Head Of Product Development and Strategy, ICICI Prudential AMC says, “While investing directly in stocks may look enticing, the rigour required in terms of research may be time-consuming and needs research expertise. In such a situation investing in index funds can be considered a stepping stone to the world of equity investing.”
What is an Index Fund?
Index funds are mutual funds that replicate a particular market index like saying the Nifty 50 or S&P BSE Sensex 30. The replication is not only in terms of the companies present in the index but also its weightage. This means an index fund will buy all the securities that are present in an underlying index in the same proportion as the underlying index.
For example, Haria explains, “Let us consider an index fund that is based on the Nifty50 index. Such an index fund will buy all the Nifty50 stocks in the same weightage as that of the Nifty50 index. As and when the Nifty 50 is rebalanced, the index fund too will mimic the changes made.”
Given the passive nature of the index fund, there is no active decision made by the fund manager here.
Industry experts say, today there is a variety of index funds offered based on indices such as Nifty 50, S&P BSE Sensex 30, Nifty Next 50, Midcap 150, Smallcap 250, Bank Index and international options such as NASDAQ 100 to name a few.
Things to Remember
1) By opting for an index fund, Haria points out, “an investor need not worry about portfolio diversification. This is because when one invests in an index fund, automatically one achieves a degree of diversification as the investment will be spread across various stocks which are all part of the index.”
2) Since index funds closely replicate the index, “the returns generated by such a fund will be similar to that of its underlying index, subject to tracking error,” says Haria.
3) The cost associated with the index fund tends to be lower. This is because Haria adds, “index funds are not actively managed and the transaction costs associated are also minimal given the low portfolio churn.”
4) Similar to other mutual funds, investors have the option of daily, weekly, fortnightly, monthly or quarterly SIP.
Haria concludes, “an index fund offers one of the easiest ways to take exposure to equity markets. Investors across the spectrum can consider having index fund as a part of their overall asset allocation.”