Today, investors are always on the lookout for investment options that can help in diversifying their portfolios. Index funds are the latest entrant as they allow investors to follow broader market indexes such as Sensex or Nifty. An index fund is a type of mutual fund which aims to mirror the portfolio of a chosen index. Index funds are also referred to as index-tracked mutual funds.
The stocks included in an index will be included in an index fund and therefore, in an investor’s portfolio. The objective of an index fund is to replicate the performance of the index that is being tracked. Most investors are attracted to index funds due to low expense ratios since these are not actively managed.
Index funds can help an investor manage his risks well since they do not aim to outperform the market but stay in parallel to the index as far as returns are concerned. For investors who are considering an investment in index funds, here is all the information needed, specifically on how to invest in index funds in India.
What are Index Funds
Index funds are a type of mutual fund or exchange-traded fund (ETF) with a portfolio constructed to match or track the components of a financial market index, such as the Standard & Poor’s 500 Index (S&P 500). They are designed to provide broad market exposure, low operating expenses, and low portfolio turnover.
In simple words, index funds are a way to invest in a diversified portfolio of stocks or bonds that mimic the composition and performance of a financial market index. They have lower expenses and fees than actively managed funds and follow a passive investment strategy.
Benefits of Index Funds
The major benefits offered by index funds are as below:
Because these are passively managed, the total expense ratio (TER) for any index fund is less than actively managed funds. An actively managed fund can have an expense ratio of 1-2%. An index fund will charge an expense ratio between 0.20% to 0.50%. While this may seem like a tiny cost difference, in the long run, it can be closer to 15% of total returns.
An index fund mostly comprises stocks of top companies from a market capitalization stand-point. This is because most leading market players are a part of the benchmark index chosen. This diversification across multiple market-cap categories allows an investor to minimise the risk of staying invested in a few chosen stocks or a particular sector.
Efficient asset allocation
Since the asset allocation in an index fund is automatic as per the index’s composition, the fund manager’s involvement is limited. This minimises losses caused by inefficiency in asset allocation.
Index funds are liquid investments and allow investors to liquidate their funds during the investment period as they are basically mutual funds that invest in the index. An investor can always redeem the index funds and the fund management companies will pay the amount back after deduction of exit load if any. This is better than ETFs where you will have to find a buyer for your units.
Ways to Invest in Index Funds
Mentioned below are the documentation requirements and primary ways of investing in an Index fund.
Here is the list of documents required for an index fund investment:
- Identity Proof (Aadhaar Card)
- Cancelled cheque
- Passport size photos
- PAN Card
- KYC documents (for KYC verification)
Index fund investments can be made through either SIP (systematic investment plan) mode or via lump-sum investment.
- SIP mode is convenient for investors who do not have immediate cash availability and would like to distribute their risk across a longer time period.
- Lump-sum investment is ideal for those who have sufficient cash availability and can handle the risk associated with a bulk investment.
Modes of Investment
Index fund investment is easy since it does not require the opening of a Demat account. You can invest in index funds using any of the below-mentioned ways:
- Direct Investment–To invest in an index fund independently, investors can visit the nearest AMC branch of the selected fund. The usual procedure would involve submission of documents, including the application form and payment to start the investment.
- Online using Fisdom App – Investors who are looking for an easy investment process from the convenience of their homes, using the Fisdom app is an ideal choice. Here are the steps to be followed for index fund investment through Fisdom app:
- Install the ‘Fisdom ’ app on your smartphone. Links to download the app are at the bottom of the page.
- Go to the Passive Index Funds card on the Home screen.
- On clicking that, you can choose to invest in passive index funds based on Nifty backers, Sensex backers, thematic funds or Global Indices
- You can choose the time horizon for your investment and choose from the chosen list of funds
- Click on the ‘Invest’ option in the fund selected.
- Choose between ‘Monthly SIP’ or ‘One-Time Lump Sum’
- Enter the amount of investment and ‘Proceed’
- Enter your PAN number and check your ‘investment readiness’ through the app
- Complete basic details along with KYC information as required
- Enter bank account details and proceed to make payment to begin investment
Things to Check Before Investing in Index Funds
Listed below are some important aspects to be considered before making an investment in Index funds:
- Tracking Error – Before choosing an index fund, investors must check for ones that have minimum tracking error. Since index funds aim to mirror the performance of an index, there could be deviations from the returns of the index. This is popularly known as tracking error. If an index fund has a lower tracking error, it indicates a better fund performance.
- Investment objective – Investors must carefully consider their investment objective against that of the index fund scheme. Both should be in alignment to fetch maximum benefits in the long run.
- Risk category – Investors must ensure a good mix of index funds and actively managed funds in their investment portfolio. This is because, during a market slowdown, the index fund valuation may slide down too. Index funds are less affected by equity-related volatility and associated risks since they follow an index.
- Expense ratio – Although index funds have a far lower expense ratio when compared to other mutual funds, the expense ratio among various index funds could vary. To maximise profits, investors must pick an index fund with a low expense ratio.
Investing in an index fund is easy. All it requires is careful consideration of investment strategy, choosing an index fund, and following the documentation to begin the investment.
Frequently Asked Questions
Which is the best index fund to invest in India?
Depending on an investor’s investment strategy, there are various index funds available in the market. Investors must carefully consider aspects such as market-cap focus, expense ratio, tracking error, etc before picking an index fund. Use the Fisdom app to invest in some of the best index fund options.
How can I invest directly in index funds?
You can invest in an index fund by either approaching the AMC office of the chosen fund or you can invest through Fisdom app, which has an easy-to-follow investment process. You can also approach a broker to initiate the investment process.
How much should I invest in index funds?
Index fund investment should be made as part of a diverse portfolio of investments. Depending on your financial capability and specific goals, you can make index fund investment with small amounts through SIP or opt for a lump-sum investment.
What are the advantages of index funds?
Index funds offer various advantages like lower expense ratio, investment diversification, liquidity, efficient asset allocation, etc.
Do index funds involve fees?
Index funds have lower management and transaction fees as compared to regular mutual funds, because these are passively managed. Also, these do not require constant revamp of stock portfolio because the strategy is to mirror an index’s stock composition at all times. This results in comparatively lower transaction fees.