Investment Tips : You want to become rich fast? Invest in low cost index funds, you want to get rich fast? Invest in low cost index funds
Index funds are mutual fund schemes that track and mirror the performance of stock market indices so as to invest in similar compositions. Therefore, the main goal of an index fund is to match the market performance. There are many such funds offered by the Indian mutual fund industry. NSC’s Nifty 50 or BSE Sensex are tracked by some very large index funds.
For example, in an index fund with a Sensex plan, 30 stocks are included in its portfolio like the Sensex. Similarly, the Nifty 50 plan fund will consist of 50 underlying stocks. Apart from this, the investment ratio in each stock will also be the same as that of the Sensex. Such an allocation of funds to the underlying stock that matches the index. Because of which that fund becomes a passive fund. This, of course, means that a fund manager does not have to actively manage the fund or do research into picking, holding, or selling stocks to build a portfolio. Hence, such funds are meant to mimic the index(s) and not outperform them.
Index funds provide investors with exposure to primarily diversified blue-chip stocks, which are well-functioning companies and market leaders in various sectors. This provides a safety net to investors as such funds are comparatively less risky than actively managed funds.
Should you invest in index funds? In this article, index funds have been evaluated on the basis of various parameters so that you can make a wise decision. Let us consider:-
cost of investing
Broadly speaking, investing should focus on two types of expenses. First- the expense ratio. This is the fee charged for managing the funds. For index funds, it is lower than for actively managed funds. This is because the fund manager has to make less active decisions regarding the composition of the portfolio. Index funds are also called low cost funds. The direct plans of index funds charge an expense fee of 0.2% (20 bsp) while the regular plans of index funds charge 0.3% to 0.4% of the total assets. Compared to index funds, actively managed equity funds tend to be more expensive – typically from 1.00% to 2.80% of assets. The expense ratio has an impact on the final return you get on your investment. Second, the exit load is charged by the fund house in case of redemption of units prior to the tenure – preferably one year from the date of purchase of those units. While many housed ones do not charge an exit load, some index funds do charge an exit load of 0.2% to 0.3% as compared to the 1-2% exit load charged on actively managed equity funds.
Risks and Rewards
Since the portfolio of such funds includes only large-cap companies, which are business leaders in their sectors, the risk associated with equity investments is significantly reduced. Because these types of companies are thoroughly researched, tracked and generally considered reliable, index funds offer comparatively more convenience to investors because of its associated The fluctuation is less.
But young investors should evaluate their risk appetite before deciding to invest in index funds. Equity funds can give far higher returns than index funds. At a later stage, as the age increases, the risk appetite decreases, so young investors can shift to index funds. You can take the advice of a financial expert for better guidance.
The main objective of an index fund is to provide returns similar to the underlying index, whereas the main objective of active funds is to outperform the benchmark indices, which will give positive returns even when the indices go into the red. can. For example, long-term annualized returns of Indian benchmark stock indices are in the range of 14-15%, while many actively managed equity schemes offer a CAGR of more than 20%. A 5% difference in returns in the long run, on a CAGR basis, has a huge impact on the creation of wealth. For example, if one invests Rs 10,000 for 20 years, and gets a CAGR return of 15%, the total investment will be Rs 1.64 lakh. Whereas if the CAGR is 20%, then the value of the investment will be Rs.3.83 lakh in the same time period. The difference with respect to returns is huge.
Also, the Indian stock market tends to do a full cycle over a period of 5-7 years, hence, the investor has to wait for at least five years to get the desired returns from index funds.
Things to consider before investing in index funds
Before choosing index funds, it is important to understand the tracking error. Tracking error means the difference between the actual performance of the benchmark and that of the scheme. While mirroring the performance of the indices and maintaining the same stock set, index funds tend to lag behind with respect to returns. The reasons behind this are stated to be expenses, cash levels in the schemes and the transaction charges involved in buying and selling the underlying stock of the index. It is generally advised that index funds should be chosen which have the least tracking error.
Should you invest?
Index funds tend to give good returns in times of market volatility. Because their returns are similar to those of the underlying indices, returns are generally predictable. Therefore, index funds work for low-risk investors with a long-term horizon to create wealth that expects predictable returns. Equity funds, on the other hand, are managed by fund managers, who keep on manipulating the portfolio based on the performance of the securities. Hence, equity funds are a better option for investors seeking higher returns, who have the guts to take on more risk. But, since diversification is the cornerstone of any investment, you can include both in your portfolio for better results as per your age, return expected, and risk appetite.
(The author of this article is Adil Shetty, CEO, BankBazaar.com)
(Disclaimer: This information is being given on the basis of expert reports. Markets are subject to risks, so take your own advice before investing.) (This article is written for informational purposes only. It is for investment purposes only.) should not be construed as financial or other advice)
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