An index fund is a type of mutual fund that follows a passive investing strategy. What this means is that, instead of actively picking stocks to invest in, the fund manager simply invests in a way that mimics the chosen benchmark. So, if you invest in a Nifty 50 index fund, that mutual fund will have all the 50 stocks in the Nifty 50 index in the same composition of the index. There are several benefits to such an investing strategy and here are some of the reasons you should consider investing in index funds.
- Broad market exposure
Index funds are a great way to add broad market exposure to your portfolio. This kind of diversification ensures good returns over the long term. That’s because, in the long term, the broader market will always outperform any one specific stock or security. So, when you invest in an index fund, you’re essentially investing in the overall market and historically, it has only gone up.
- Simple and transparent
Unlike other mutual funds, index funds are not aiming to beat their benchmark index or outperform the market. The only goal of index funds is to mimic its benchmark index and give the same returns with minimal tracking error. Thus, they are not complicated investments where the investment strategy used is difficult to understand.
- Low-cost investments
Since index funds follow a passive investing strategy and the fund manager only has to track the benchmark index without aiming to outperform it, the expense ratio of index funds is lower than that of actively managed mutual funds. So, when you invest in index funds, you are benefiting from lower costs.
- No human bias
The performance of actively managed mutual funds greatly depends on the fund manager’s strategy and experience. However, that is not the case with index funds. Index funds completely do away with human bias when it comes to decision making and asset allocation and this can be beneficial for your portfolio.
- Flexibility and convenience
You can choose to start a Systematic Investment Plan (SIP) in an index fund of your choice with as little as Rs 500. This allows you to regularly invest small amounts in the stock market through your chosen index fund and benefit from wealth generation over time. You can meet your long-term financial goals such as buying a home, funding your children’s education, etc., through SIP investments in index funds for the long term.
Index funds are as many different kinds as there are stock market benchmarks. You need to decide if you want to invest in the overall market or a specific part or sector of it. For instance, you can invest in a Nifty 50 index fund or if you want to invest in a specific sector such as banking, you can invest in a Nifty Bank index fund. Hence, you need to first figure out what kind of exposure you want to add to your investment portfolio and then pick an index fund accordingly.