Earlier, you could invest only in traditional bank instruments that would earn you fixed-interest returns. However, with time, investment instruments have evolved. You can now find several investment instruments. Market-linked instruments are highly popular. They earn you decent returns and let you enjoy high liquidity. Index Funds are the finest market-linked instrument to explore. It is a Mutual Fund that imitates a stock market index.
Your investment returns and risks depend on the market index's performance. Benchmark index, market capitalisation index, and sectoral index are the most common market indexes you can choose from. You can invest in Index Funds in two ways: Lumpsum Investments or Systematic Investment Plans.
Both modes offer reasonable returns and promise incredible investment flexibility. Following is a detailed guide on Index Funds' returns and risks.
How do Index Funds earn you returns?
Let us understand this with an example. You choose BSE Sensex, benchmark index, as your tracking stock market index. Since Sensex includes the top 30 performing stocks listed on the BSE, these top 30 stocks are part of your investment portfolio in a similar proportion. You need to check the BSE Sensex value to gauge your Index Fund's performance. If your tracking stock market index performs well, so does your Index Fund.
Index Mutual Funds earn you decent and often predictable investment returns. Note that as Index Funds replicates a stock market index performance, they cannot outperform it. Hence, you cannot expect your investment to earn you exorbitant investment returns. Consider this aspect before investing.
What is the risk associated with Index Funds?
Index Funds are considered a safer investment option than other Mutual Funds. This is because it encourages you to create a diverse portfolio. Stocks are included in portfolio in a reasonable proportion. So, even if one stock takes a hit, your entire investment is manageable and does not bear significant loss. Furthermore, choosing a benchmark index like BSE Sensex or NSE Nifty to invest in Index Funds reduces the associated investment risk.
Sensex and Nifty include top 30 and top 50 stocks, respectively, listed on their respective stock exchanges. You can consider it to be the cream layer of the market. Investing in such stocks often reduces risk levels and earns better returns. Given this explanation, people think Index Funds are safeguarded from market volatility entirely. However, that does not happen. If the market positioning is vulnerable, every stock takes a hit.
Hence, prepare to cope with market volatility. A better way to tackle market volatility is investing via SIPs. Here, you can make small, periodic contributions to your investment. This ensures that a significant lumpsum amount is not at risk when the markets are down.
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