What is an Index Fund? Meaning and How Does it Work in India

Investors have plenty of options in today's market with a diverse variety of firms listed on the stock exchange, and many available sub-categories based on market sizes, themes, risk profiles, and credit ratings. But what is an index fund that people talk about all the time? Well, index funds were created to help investors navigate the obstacles of picking a portfolio of assets that matches their financial goals! This is because navigating all the investment possibilities and constantly reviewing their risk profiles, growth potential, and values can be difficult for investors. Now, let’s take a look at index funds and how they benefit investors.

What is an Index Fund?

An index fund is a type of unit investment trust (UIT) that seeks to achieve roughly the same return as a specific market index, such as the S&P 500 Composite Stock Price Index, or the Wilshire 5000 Total Market Index. When you invest in index fund, it seeks to meet its investment goal primarily by investing in the securities (stocks or bonds) of firms included in a certain index!

Some index funds may also utilize derivatives such as options or futures to assist investors meet their investing goals. Certain index funds invest in the whole index, while others invest in a representative sampling of the index funds, as a result, they have become safe investments with high returns in India. Index fund management is more passive than non-index fund management since it just requires tracking a relatively set index of securities, and that often results in less portfolio trading, better income tax outcomes, and cheaper fees and expenditures.

How Index Funds Work in India?

When you invest in an index fund, no matter if it is a large cap or mid cap index fund, the fund manager invests your money in equities in proportion to the index he is monitoring. A NIFTY Index Fund, for example, invests in stocks of firms that make up the NIFTY 50 Index in the same proportion and this is done with the goal of achieving a return equal to the index.

If a stock's value in the index increases or decreases, the fund manager of an Index Fund will reflect such changes in his fund. Similarly, if a stock is removed from the index and a new stock is added in its place, the Index Fund's fund manager will sell all of their holdings in the removed stock and purchase the new stock in the same proportion as it appears in the index.

These funds have extremely low cost structures since they do not have a management team and do not actively buy and sell equities, as a result, index funds are the cheapest funds to invest in with a high index funds returns opportunity.

Who Should Invest in an Index Fund?

Check out who is the best candidate for index investing:

• Investors interested in a simple investment method

  Unlike actively managed funds, index funds do not require ongoing performance monitoring because the Index funds' portfolios and performance are directly related to a single index. The fund's holdings reflect the composition of the underlying index, eliminating the need for periodic evaluations and monitoring! This is the big factor that makes it an attractive alternative for investors who prefer a hands-off strategy that removes the need for active stock selection all the time. Choosing index funds allows investors to have a hassle-free investment experience while still benefiting from the overall market success.

• Investors who are satisfied with market-level returns

  If you are satisfied with the general market level returns and do not want to take on more risk in quest of better returns, index funds are ideal for you! These funds mirror the performance of a certain market index which in turn guarantees that the returns earned are closely related to the market itself. As a result, index funds are especially useful for new investors who want to obtain market-linked returns that are roughly comparable to those generated by the index.

• Investors who want to reduce personal bias

  Personal biases can impact an individual's investment decisions because fund managers may have their own opinions and convictions that can actually influence their investing decisions. This happens all the time in certain investment options, and results such as ULIP NAV can be complicated to understand! In contrast, index funds reduce human bias in investing decisions as they merely reproduce the index according to predefined rules, allowing for fair investing and also reducing active stock selection risk.

How to Invest in an Index Fund in India?

If you want to invest in the market but do not have much knowledge of finance, it is best that you talk to a financial expert. They can give you details of index funds, how to start one, or even explain other factors such as all about SIP investment. The benefit of speaking with an advisor is that you may take an organized approach from the start of your investing journey because this way you construct a financial strategy, define your investing objectives, and then choose your funds with a specific purpose in mind.

Here, we have mentioned the steps of starting an index fund both online and offline.

Online Process

• Create an account on any secure website of your choosing, and complete your KYC requirements and go to the next section.
• Enter the relevant information as needed and choose the fund(s) in which you want to invest based on your financial objectives.
• Select the relevant fund and transfer the specified amount from your bank account.
• You may also set up a standing instruction with your bank if you want to invest regularly via SIP, which stands for a systematic investment plan.

Offline Process

• Fill out the application and KYC forms carefully and submit them.
• Add the required information as needed and choose the fund(s) that best suit your financial needs.
• Pay the investment amount using the payment option that is most convenient for you.

All funds come with certain benefits and drawbacks, in the case of an index fund, you receive market-level return without much risk, however, you do not receive the benefits that certain other investment methods such as ULIP plans offer. The mortality charges in ULIP is widely considered a great benefit for the investor, however, the attention and time you have to spend for an ULIP plan isn’t necessary for an index fund!

Benefits of Investing in Index Funds

Index funds have increased in popularity in India because they provide several advantages over traditional actively managed funds, so, let’s take a look at these benefits to give you a more in-depth understanding of the fund.

• Low Cost of Investment

  One of the best benefits of index funds is that even the greatest Index Fund does not require a staff of experts to investigate the best available investments or identify market patterns to determine the optimal moment to enter and leave specific equities. Thus, the cost of administering an Index Fund is much less than that of an actively managed Equity Fund! What's more, even the top index funds in India do not participate in active trading, and that factor decreases portfolio turnover and results in a lower cost ratio for index funds compared to actively managed schemes.

• Simple to Manage

  When thinking about investment, people have to worry about so many factors and learn finance knowledge such as what is small cap mid cap and large cap investment, etc. Index funds, on the other hand, are easier to handle than actively managed funds since their asset allocation does not change often! This implies that once you invest in an Index Fund, its asset allocation remains constant until you choose to modify it or another manager replaces your present one.

• No Fund Manager Bias

  Among the benefits of investing in index funds, this one stands out! In the case of an Index Fund, the fund manager just duplicates the index that is being followed, thus there is no bias in-stock selection. For example, an Index Fund following the NIFTY Next 50 Index will only invest in the 50 equities that make up the Next 50 Index. Personal bias is eliminated since the fund manager does not have to choose and invest in equities on his or her own, nor does he or she have to time the entry and exit into particular stocks.

• Diversified Investments

  An Index Fund's portfolio duplicates the chosen index in every way, which allows investors to diversify their assets across several industries with minimum risk! Actively managed funds are rarely able to provide such a high level of portfolio diversity at such low expenses, and that is a superb benefit.

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