An index in the stock market is an indicator that measures the performance of the stock market, or a part thereof. Nifty, for instance, is the weighted average index of 50 top Indian companies listed on the National Stock Exchange. All major stock exchanges have one or more indices that use the exchange as a benchmark of the market movement, be it S&P 500 that tracks NYSE and NASDAQ, or the Sensex that is based on the BSE performance.
What is an index fund?
Index mutual funds follow the performance of these indices as a measure of a rise or fall in its value. Mutual funds can be active or passive. In an active mutual fund, the fund manager is actively involved in increasing the return of the fund. Index mutual funds are passive funds, where the corpus of the fund is invested in the stocks included in the index. It also invests in the same proportion as is done by the index.
Why should you invest in it?
Consistent performance – As history has shown, stock indices have shown consistent growth in the long run. Indices like Nifty and Sensex have always shown healthy growth when seen in a decade or multi-decade time horizon. While you may not get a windfall return that an investment in a hidden gem would bring, an index mutual fund SIP delivers steady, long-term returns.
Free from human error – Index mutual funds undergo minimum human interference. There are no investment strategies or managerial discretion involved, making it immune from bias and error of judgment. They remain largely on an auto-pilot mode, following a trusted index as a benchmark.
Cost-efficiency – Due to the absence of an active fund management team, the mutual fund company can offer index mutual funds at much lower charges. The expense ratio is low, which ensures that you have maximum return on the growth of the fund. If a particular SIP interests you, you should check how closely it reflects the index. If the differences are minor, you may end up paying a higher fund expense for marginal benefits.
Risk efficiency – As they lean on an underlying index, index funds are less prone to sectoral and other specific equity-related volatility. If you see a booming stock market, investing in index mutual funds online can be a quick way to grab high returns.
Things to keep in mind
Despite the lack of human interference, index mutual funds are prone to tracking error which can occur due to index constituent changes, corporate activities, liquidity provisions etc. The absence of human interference also means the absence of a fund manager who can maximize the fund’s value through smart trading. Besides, in the event of a market crash, the worth of index mutual funds might also take a fall.
In any case, a smart investment strategy and regular monitoring can help you to avoid unpleasant volatility. Using Tata Capital Moneyfy app to manage all your investments in one place and achieve high returns from your index fund investments too.