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How to Start Investing In Index Funds – Working, Benefits and Disadvantages


Funds that follow the index are known as Index Funds. Investing in Index Funds considered one of the smartest investment choices as they do not involve active management.

What is Index?

An investor can monitor the performance of various assets by tracking their price movement. A systematic method of monitoring the performance of a collection of stocks, assets, etc. is called index.

How does an index fund work?

how does an index fund works

Index is made up of securities or stocks that fulfill a certain criteria. Indices can be broad-based or may monitor the performance of particular industries, stocks, etc. Since index is a benchmark for a defined market segment, its portfolio will consist of the same stocks as the Nifty 50 or Sensex 30.

Index funds are classified as passive fund management. According to the composition of the underlying benchmark, the fund management chooses the equities that need to be bought and sold. Since the index funds follow an index, there are no research experts to spot opportunities and choose stocks, unlike actively managed funds.

An index fund matches the performance of its index, as opposed to an actively managed fund that reacts with the opportunities in the market and result in profit or loss. It is also the reason why the index funds matched the funds of the underlying market index.

Benefits of investing in Index Funds

1. Low fees:

These funds have considerably low fees. Actively managed funds, in contrast to index funds, have significantly higher expenses and lower returns than the market. As per the existing data of Moneycontrol, many large cap funds have been unable to beat Index Funds in the last 5 years This is due to the fact that an index fund manager must only purchase the stocks or other investments included in an index.

2. Not much experience required for investing in Index Funds:

These funds are considered best for first time investors as they do not require much knowledge while investing in Index Funds.

f investing in Index Funds

3. Contains a variety of investment:

Index funds are diversified. Thus, while investing in Index Funds, an investor can use stocks from the stock index funds that are also a well-known strategy.

4. Saves a lot of time:

Investing in index funds saves a lot of time. This is due to the fact that index funds allow an investor to invest in an index that already contains the stocks of well-established companies. This as a result, minimizes the amount of effort that an investor has to spend while researching individual stocks.

5. Are easy to manage:

Since fund managers do not need to monitor the performance of specific stocks inside the index, these funds are easier to administer than other funds. In fact, fund managers are just obligated to periodically rebalance the portfolio when the index rebalances.

Disadvantages of Index Funds:

disadvantages of investing in index funds

1. Tracking Error:

As a mutual fund scheme, the Index Funds tries to replicate the target index. The Investment manager holds all the securities in the Index to replicate the results of the target Index. But, there are instances where there is an annualized standard deviation of the difference in return between the Index Funds and target index. Thus, while investing in Index Funds, an investor can use tools/websites that provide with the Index is an open ended fund, on a regular basis.

Unless the fund manager adjusts the fund holdings according to the target index, there will always be tracking error present in the fund.

2. Lack of Reactive Ability:

Index investment does not permit profitable conduct. When a stock is overvalued, the index really starts to give it more weight. Unfortunately, this is precisely the time when wise investors would wish to reduce the stock’s exposure in their portfolios. Therefore, if an investor is investing in Index Fund through an index, they won’t be able to act on their knowledge even if they have a clear understanding of a stock that is overvalued or undervalued.

What to consider before investing in Index Funds

1. Expense Ratio:

It refers to the small percentage of the total amount that is charged by the fund house towards fund management services. Because it is a passively managed fund, there is no need for an investment strategy or selecting stocks for exchange. The fund manager costs down which ultimately lead to a low expense ratio.

2. Investing according to investment plan:

While investing in Index Funds, investors should plan their long-term investment horizon can consider investing in Index funds. Also the investment plan should be made in such a manner that it meets the investment-goal set by the investor.

3. Tax:

When compared to Income Tax, taxes on Index Funds are more favorable for an investor will have to pay 10% tax for LTCG (Long-Term Capital Gains) while an individual can be charged a maximum of 30% as income tax on their income.

Which Are The Best Index Funds To Invest In India?

best index funds to invest in India

It’s difficult to avoid looking at the best-performing funds every year when selecting the best investments because doing so will allow the investor to gradually add a number of Index  mutual fund schemes to their portfolio.

Avoiding having a lot of different funds in the portfolio is the main goal of investing in index funds. Sensex 30 and Nifty 50 flagship funds and covers majority of the market.  Long-term investors can make investments in these funds and watch their money grow over time. 

Investors can start investing by opening a free demat account with SMIFS. However, before anyone can start investing, gathering information about the funds is important. Fortunately, our dedicated research team is ready to help by providing with stock recommendations in order to maximize profits.


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