Investing in equity has never been an easy task. It demands a lot of time and effort from your side to understand the company’s business, analyze the financials, develop the investment philosophy, and whatnot.
So, you invest in mutual funds, giving your money to a professional fund manager who will manage and invest it in equity markets. But he is going to charge fees for his professional services, and there is no assurance that he will be able to generate a good return.
Then you might ask if there is any way by which you can invest in equities where you will not be required to put the effort like a professional fund manager or pay hefty professional fees, and yet you can earn a decent return. The answer to this question is index funds.
In this article, we will see an index fund, its benefits and limitations, how to invest in index funds in India, how to buy index funds in India, and some points about ETFs.
What is an Index Fund?
Index Fund is a mutual fund where the fund manager invests in stocks that are part of a particular index called the underlying index.
Here, the fund manager does not use his professional skills but replicates the index with the objective of earning a return (before fees and expenses) that is commensurate with the return of the underlying index.
Since the fund manager does not apply his professional skills and the fund is managed passively by just copying the index, the expense ratios of index funds are also very low. Hence, index funds are the best passive funds.
Benefits of Index Funds
- Lower Fees: Since the fund manager is not required to manage the funds actively and invest by replicating the underlying index, index funds have lower expense ratios than actively managed funds.
- Zero Risk of Fund Management: The risk of the fund manager’s decisions going wrong is eliminated because the fund manager mimics the underlying index.
- Easy to Invest: Index funds are easiest to invest in because it requires very little application of financial knowledge than actively managed funds.
- Diversification: Generally, indices are well diversified, and since index funds invest in stocks that form part of that index, you get the benefit of diversification automatically.
Due to the benefits mentioned above, index funds are the best passive funds to invest in.
Limitations of Index Funds
The only considerable limitation of index funds is that you don’t make returns higher than the index; you can make the maximum that index has made but not more than that.
How to invest in Index Funds in India?
Once you have decided to invest in index funds, you can follow the following approach for investing in index funds.
- Selection of the appropriate underlying index: Based on the time horizon and your risk appetite, you must select an appropriate underlying index for your investments.
- Selection of appropriate index fund: Once you have chosen the underlying index appropriate for you, you have to select the index fund with the index that you have chosen as its underlying. With the help of the following factors, you can decide the best index fund to invest in.
- AUM: Consider the funds with the highest AUM because the higher the AUM, the more the chances of being better managed.
- Expense Ratio: Since there is no active management of funds, you should consider the funds that have the lowest expense ratio, so you incur lesser costs.
- Tracking Error: Tracking error measures the difference between the returns generated by the index fund and the underlying index. The lower the tracking error, the better it is, as you get returns like the underlying index as much as possible.
How to buy Index Funds in India?
After deciding to invest in index funds, you might have a question about how to buy index funds in India. Don’t worry.
The procedure to buy an index fund is simple and the same as the procedure for buying any other mutual fund. You can visit the official website of the mutual fund, complete the standard KYC procedure, and fill up the required information for buying the index funds.
You can also invest in index funds in India using our EduFund App without paying any commission in a simple and hassle-free manner.
What is an ETF?
ETF is also an index fund. The only difference is ETFs are traded on stock exchanges like normal stocks. There are also ETFs based on commodities like gold, silver, etc.
You can consider the parameters of liquidity and volume in addition to the approach given above to decide the best ETF to invest in India. You can also invest in the best ETFs in India through our EduFund App.
Conclusion
Index funds and ETFs are the best way to start investing, considering the benefits and limitations. However, time spent in the market is much more essential to create wealth.
Hence, it would help if you focused more on staying invested for a longer duration than deciding which is the best index fund or the best ETF to invest in.
