Whether you are a beginner or a seasoned investor, it is a given that the key to building a profitable investment portfolio is diversification. This is where Index Funds can be an excellent choice. They allow you to invest in the shares of different companies across different sectors and with varying market capitalisation levels.
What are they?
Index Funds invest in stocks that mimic a stock market index, for example, BSE Sensex, NSE Nifty, etc. The fund manager passively manages them and invests only in those securities and in a similar proportion to match the stock market index it follows. Hence, the fund manager only copies a stock market index when creating a particular Index Fund portfolio and maintains it in tune with the chosen index.
Benefits
Some of the benefits of Index Funds include the following:
Allows diversification
Mutual Funds that include higher holdings in their portfolio often possess lower risk potential than those with significantly smaller holdings. This is because if some stocks underperform, others provide a cushion and may lower the losses. Since Index Funds are linked to an index, you can tap the returns of a large market segment that includes a significantly bigger pool of holdings.
This advantage makes it less risky than funds that include fewer holdings. Hence, people with a lower risk appetite may benefit from investing in them.
Passively managed
Under Active Funds, the fund manager's role is crucial since they continuously track the markets to rebalance the portfolio and make maximum gains. Hence, an inefficient manager can dampen your returns. Meanwhile, when you invest in Index Funds, the fund manager adjusts the portfolio of the stocks in proportion to the changes in the index it is linked to.
This adjustment is simple and does not require the services of a highly skilled manager to recalibrate the stocks.
Lower expense ratio
Since Index Funds need not be actively managed and the fund manager does not constantly track the buying and selling of stocks to maintain a profitable portfolio, the management cost is significantly lower. Hence, when you invest in these funds, they come with a considerably lower expense ratio, and the savings from lower expenses are passed on to you.
Enjoy tax benefits
Index Funds do not provide high capital gains. Hence, you need not pay a lot of capital gains tax.
Flexibility
If you are wondering how to invest in Index Funds with a small capital, these funds generally allow you to invest small sums regularly. You can opt for Systematic Investment Plans if you do not have a huge capital to invest in one go.
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