What are Index Funds?

Index funds, as defined by SEBI, are open-ended schemes which track or replicate the market’s index. According to SEBI’s guidelines, the minimum investment in such securities needs to be 95% of the total assets. 

More about index funds

Index funds are a certain type of mutual fund. Index funds develop their portfolio by tracking the composition of one or more standard market indexes like Sensex and Nifty 50. Index funds invest in both of them, which make up the benchmark index as present in the index targeted. These seek to follow the performance of one or more indexes in terms of their returns at minimal cost. These are called passive funds too since these don’t need a high level of active management. And since there is no need for an active management, it makes index funds more cost-efficient than actively managed funds.

What are the features of an index fund?

• Index funds can be taken as a long-term, less risky form of investment

• The success of these funds predominantly depends on the choice of index and their low volatility

• Since these funds create a portfolio that almost replicates the chosen index, the returns offered by these funds are also similar to that of the index

• Given the dependence of these funds on the performance of an index, index funds are passively managed; hence, these funds are not meant to outperform the market but instead mimic the index’s performance

• Due to the passive management of these funds, they involve lesser expense ratio and thus, low expenses

• Index funds are, additionally, known to provide broad market exposure and low portfolio turnover to the investors

What are the benefits of having an index fund?

There are several benefits in having index funds. These are: 

1. Low cost: As said before, index funds are passively managed. This means that there is no need for an active management. This makes index funds more cost effective, than let’s say, most other mutual funds. Actively funds may charge you anywhere from 1-2 percent, while passively managed ones charge 0.50% at the most as TER. This cost difference may not seem like much right now, but in the long run, the difference can be as much as 15% of your net returns.

2. Diversification: Index funds are highly sought after because these are made up of securities of the top companies in terms of market capitalization. This means that the following benchmark index will be made up of top companies in the industry sector. Due to such diversification, investors are relatively safer from risks of investing in just one company or industry.

3. No errors: Index funds are not actively managed by a manager, and so there is no room for error. 

The best index funds for 2021