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Index Funds 101

By HARSH AGARWAL

6th Jun 2022

2 mins read

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Have you ever had the chance to make a ready-to-eat meal, where all the ingredients are in perfect harmony, waiting for your Michelin level microwaving skills? The concept of an index fund is close. A fund manager invests assets into stocks in proportions already defined in pre-established indices.

A ready-to-consume investment instrument sounds interesting? Let's dive a bit deeper into this topic.

What are index funds?

These are passively managed funds that invest in stock to mimic the movement of market indices. The fund managers don't cherry-pick the stocks but rather plainly invest in all the stocks in the index in varying proportions.

Benefits of index funds

  • Lower Expense Ratio - As these funds are passively managed, they typically charge a lower expense ratio. Thus, the investor takes more returns home.
  • Lower Risk - These funds, aggregate of multiple stocks, are less likely to be volatile, thus lowering the risk profile of the investment.
  • High Returns - Index funds have historically given good returns in the long run.

Things to consider

  • Underperformance - Although based on established indices, these funds underperform due to the expense ratio.
  • Tracking difference - Tracking difference is the difference between the performance of the fund and that of the benchmark index. This may be positive or negative, i.e., a fund may underperform or outperform the index.
  • Passively managed funds - When the market's rising, the index funds offer great returns but being passively managed, the fund managers don't reallocate the assets to hedge against the slump. Thus, an actively managed fund proves to be a better option when markets fall.

Some Indices and Funds based on them

  • Nifty Index - DSP Equal Nifty 50 Fund, IDFC Nifty Direct Plan, Aditya Birla Sun Life Nifty 50 Index Fund
  • BSE Sensex  - ICICI Prudential Sensex Index Fund, HDFC Index Sensex Plan
  • S&P Index - Motilal Oswal S&P BSE Low Volatility Index Funds

That was a quick and short blog on Index funds. Remember, the ready-to-eat packets are quick and easy to make but can be real disappointments when they do!

We'll be back with another recipe...blog...another blog. Till then, Stay Safe! Invest Safer!

FAQs

Q. How are these indices created?

Ans. Indices are created by a bunch of similar companies in terms of industry, market capitalisation amongst other things. 

Q. How are index funds taxed?

Ans. These funds are usually taxed like equity funds unless they consist of foreign equity or debt instruments in which case they are taxed like debt funds.

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Made with ❤️ in India