When it is about accumulating wealth, investment in the stock market tends to sit at the topmost list of many. Note that your investments may reward you well only if you are willing to remain invested for a long-time period. Nonetheless, with this comes an inherent risk that you may have to face. In case the stock market underperforms, then you can lose a substantial portion of your earned returns and capital. To lower the market risk exposure, investing in low-cost index funds is one of the prudent strategies.
In case, you are wondering what an index fund is, discussed here are all the important details you must know about.
What is an index fund?
An index fund is a kind of mutual fund where your money is invested in companies’ stocks that feature in a stock market benchmark index. For instance, a Nifty 50 index fund is prepared in a manner that the constituents of the fund match with companies in the Nifty 50 index. Hence, the performance of the index fund mimics that of the index.
In the case of conventional mutual funds, the fund manager selects the stocks depending on specific parameters. However, such funds hardly offer broad market exposure. As an outcome, the NAV (net asset value) may fall, even when markets are performing well because of the underperformance of a few of the selected companies’ stocks in the mutual fund portfolio.
Such a case is very unlikely to take place when you invest your funds in an index fund because the underperformance of specific stocks is balanced by other outperforming stocks. Thus, an index fund allows you to lower your market risk that you may otherwise be exposed to. Index funds also endow you with safety and stable returns over the long term.
What are the benefits of investing in index funds?
- Bias elimination
No matter whether you are an individual retail investor or fund manager, it is difficult to put your emotions aside when selecting stocks for investment. However, with index funds, there’s no emotional bias and the selection of stocks here is thoroughly objective as this fund mirrors the chosen benchmark index.
- Reduces risk
As index funds’ stocks are identical to the selected index, it becomes simpler for you to enjoy wider exposure to the market, thus effectively diversifying your investment portfolio and lowering the associated risk. As you get exposed to distinct market sectors and industries, your returns are not impacted even if a specific sector underperforms.
- Low cost
Since index funds are passively managed, the expense ratio in index mutual funds tends to be lower than that of actively managed mutual funds. Hence, index funds are a great way to invest in the stock market because the expense ratio often tends to be less than 1%.
What is the process to invest in an index fund?
Step no. 1
Decide which index you want to invest in. For instance, Nifty 50, BSE Sensex, etc. This is important because once you have decided this you can look at the various index mutual funds based on this index. There are several indexes ranging from broad-based market indexes to sector-specific indexes.
Step no. 2
Create an online account with the mutual fund house or broker of your choice. Upload the necessary documents such as your Aadhaar card, PAN, etc., and finish the KYC compliance process.
Step no. 3
After registering, browse to the section “mutual fund” and select go through the available index funds. Before you choose the index fund option, ensure to conduct a comprehensive analysis and review of its past record and performance. Also, make sure you go through the scheme-related documents to make an informed decision.
Step no. 4
Once you have zeroed in on the index fund, you can either begin a Systematic Investment Plan (SIP) or purchase the fund units through the lumpsum mode.
Ending note
By following the above steps, you can invest in the index funds of your choice. Investing in an index fund can enhance the chances of your investment performing well in the long term, thus allowing you to meet your life goals. Moreover, as such funds are managed passively, you do not require spending time monitoring your investment portfolio.
