How to Choose The Right Index Fund?
With the recent developments in the capital market, more and more instruments are created to try to cater to as many types of investors as there are present in the market by creating and distributing instruments with as many benefits and with as less risks and downsides as possible. One such instrument which is very simple to understand and is accessible to almost everyone is an index fund. But how exactly is investing in index funds beneficial? How can one determine which index fund is the correct one for him/her? And what are some of the best index funds the market has to offer? All of these questions will be answered in the following article.
Benefits Of Investing In Index Funds
As we have understood, the structure of index funds combines the characteristics of both market indices and mutual fund investment schemes. It is only natural that index funds carry the benefits of both market indices and mutual funds as well. With this in mind, let us discuss some of the benefits that investing in index funds can bring.
Diversification
Market Indices, whether they be of any type, are made up of a large number of companies’ securities and unless the index is a sector index, these companies also belong to various sectors. Since these market indices are replicated by the index funds’ investment portfolios, this level of diversification is also achieved by the index funds, resulting in the reduction of risks of the fund underperforming.
Passive Management
Since the index fund manager’s responsibility is only replicating the composition of the market index the fund is tracking, the manager is not burdened with constant divestment and investment and tracking of various sectors and companies in an attempt to try and outperform the market’s returns. The manager can just track the market index and replicate it and that is all. This results in the fund management fees getting significantly lower than the actively managed funds, and lower fees result in greater returns.
Professional Management
The index fund is managed by professional managers. These professional managers have been in the industry for years and they have much more experience and knowledge about managing investments than a retail investor does. This means that the investors’ money is in better hands since the chances of making errors or investing in underperforming securities are much lower. Hence, risk is reduced and returns are maximised due to professional management.
Exposure To Various Sectors
Unless the index being tracked by the index fund is a sector-specific index, investing in an index fund gives the investor’s portfolio exposure to various sectors and industries of the economy. Among its many benefits, perhaps the biggest benefit of this is the portfolio has a lower risk of underperforming regardless of which stage of the business cycle the economy is in.
Exchange-Traded Options
Many of the index funds are also offered to investors in the form of exchange-traded funds. This means that these index funds are traded on stock exchanges just like individual stocks are traded, increasing the availability and liquidity of such index funds.
Long-Term Growth
Every investment goes through a cycle of highs and lows, and so does investing in index funds since no economy and no sector (with some exceptions) is going to perform well all the time. In the long run, however, these are investment avenues that grow, and they grow significantly. Hence, if investment in index funds is done with consistency and discipline, it leads to great returns in the long run.
How To Choose The Right Index Fund?
A lot of factors need to be considered when deciding which index fund to invest in. Some of them due to their nature as mutual fund investments and some of them due to their tracking of market indices. We shall be listing some of them out here:
Choosing The Correct Index
Since index funds are called so because they track and replicate a specific market index, the first thing the investor must see is what index is being tracked by the index fund. Clearly, an investor looking to reap returns from the upcoming nature of the technological sector would not find an index fund tracking a banking-sector index to be an ideal investment. Similarly, an investor who wants their investments to be safe due to the diversification provided by a large-cap index like NSE Nifty 50 would not want to invest in an index fund that tracks a geographical index consisting of companies from just a specific state. Hence, it is important that the investor’s goals align with the characteristics of the index being tracked by the index fund in question.
The Fund’s Risk And Return Statistics
Every fund has its historical and predicted returns and a risk profile. Some funds are going to provide higher returns but at a higher risk profile than the funds that are relatively safer while offering lower returns. Every investor has a different appetite for risks and different goals for the returns they expect. Hence, it is upon the investor to find the balance between the risk and return stats and choose which one suits their goals and appetites the best.
Tax Efficiency
Although index fund investments by themselves do not qualify for tax savings under Section 80C of the Indian Income Tax Act, Equity Linked Saving Schemes (E.L.S.S.) do, and some fund houses have started combining E.L.S.S.s with index funds. So, if an investor wants to take advantage of this feature, he may opt to invest in such E.L.S.S. + Index Fund combinations.
Fund Manager
All the fund houses specify who is the fund managers for their fund. An investor may choose the fund they want based on the fund manager’s credentials.
Exchange Rates
With the advent of globalisation, options have opened up for investors to invest in index funds tracking not only Indian securities but in stocks of international stock exchanges as well. At the same time, investors may even invest in index funds offered by international fund houses. In such cases, investors must check what is the exchange rate being offered between the domestic currency and the foreign currency.
Expense Ratios
Expense Ratios are the fees charged by fund houses to manage and provide you with the fund. Different funds charge different percentages of the A.U.M. as expense ratios, and a lower expense ratio could mean higher returns. At the same time, investors should also look if any additional fees are being charged such as transaction fees, redemption fees or any other such fees.
Top 5 Index Funds To Invest In 2024
Although index funds can be classified from various angles, one broad classification is whether the index fund is tracking a broad market index like the NSE Nifty 50 or the BSE Sensex or it is tracking a sector index such as the Nifty Next 50 IT. We have already provided a comprehensive list of the top 10 broad market index funds to invest in 2024 in this article. In this article, we shall be listing the top 5 sector index funds to invest in 20024.
Tata Digital India Fund
The Tata Digital India Fund is offered by Tata Mutual Fund. The fund has been going on for a period of 8 years and 9 months, reaping returns of 22.83% annually on average during this time. For the last year, the fund’s return was 47.37% and its risk profile is relatively low. It invests almost 80% of its fund corpus in the technology sector, with Infosys Ltd., Tata Consultancy Services Ltd., Tech Mahindra Ltd., HCL Technologies Ltd., and LTIMindtree Ltd. being its top investments. Tata Digital India Fund charges an expense ratio of 0.35%.
Nippon India Banking & Financial Services Fund
The Nippon India Banking & Financial Services Fund comes from Nippon India Mutual Fund. The fund has been running for 11 years and 8 months, and over this time, has brought an annual return of 15.37% on average. It has a lower-than-average risk level and for the last year, earned a return of 31.68%. Over 95% of the fund corpus of this fund is invested in the financial and insurance sector as its top holdings are HDFC Bank Ltd., ICICI Bank Ltd., Axis Bank Ltd., IndusInd Bank Ltd., Kotak Mahindra Bank Ltd., State Bank of India and SBI Life Insurance Company Ltd. The fund charges an expense ratio of 1.08%.
HDFC Defence Fund
The HDFC Defence Fund is a product of HDFC Mutual Fund. A fairly newer fund going on for just a year and 4 months, it has earned a return of 82.22% for this period while for the previous 1 year, the percentage of return was 85.28%. The fund invests over 60% of its funds in the capital goods sector, followed by the chemicals sector and communication sector, having its top holdings as Bharat Electronics Ltd., Hindustan Aeronautics Ltd., Cyient DLM Ltd., Solar Industries India Ltd., Astra Microwave Products Ltd, BEML Ltd. and Premier Explosives Ltd. The HDFC Defence Fund charges an expense ratio of 0.72%.
ICICI Prudential Infrastructure Fund
The ICICI Prudential Infrastructure Fund comes from ICICI Prudential Mutual Fund and has been running for 11 years and 8 months. Over the time it has been running, it has earned an average annual return of 19.04% while for the last year, it earned a return of 62.28%. It is considered a fund with one of the lowest risks and hence its expense ratio is also higher than what other sector index funds charge at 1.18%. The sectors that this fund majorly invests in are Energy, Financial, Construction, Metals & Mining, Materials and Capital Goods sectors, Larsen & Toubro Ltd., NTPC Ltd., ICICI Bank Ltd., HDFC Bank Ltd., Kalpataru Projects International Ltd., Gujarat Gas Ltd. and NCC Ltd. being its top investees.
Nippon India Power & Infra Fund
The Nippon India Power & Infra Fund is a fund offered by Nippon India Mutual Fund and has existed for 11 years and 8 months. For the last year, it generated returns of 65.85% while over the tenure it has existed, it has earned returns of 17.77% annually on average. It has an average risk profile and invests majorly in the Capital Goods, Energy, Construction, Materials, and Communication sectors. The top investees of the fund are Larsen & Toubro Ltd., Reliance Industries Ltd., NTPC Ltd., Kaynes Technology India Ltd., Bharti Airtel Ltd., Bosch Ltd. and Ultratech Cement Ltd. and the fund charges an expense ratio of 0.98%.
Frequently Asked Questions
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Do Index Funds invest in stocks only?
While index funds typically do invest in equity securities, there are also index funds that invest in debt securities i.e. bonds and debentures, in commodities like precious metals, crops or oils or even in real estate investment trusts (REITs). -
Does investing in index funds provide tax benefits?
Index funds, by themselves, do not qualify for tax benefits under Section 80C of the Indian Income Tax Act. However, some fund companies now provide a combination of E.L.S.S. and Index Funds since E.L.S.S.s qualify for tax benefits under Section 80C of the Indian Income Tax Act and such instruments bring tax benefits as mentioned under the article https://www.insurancedekho.com/investment/news/sip-tax-benefits-under-section-80c-10375 -
How does being an exchange-traded fund make Index Funds more accessible and liquid?
Being an exchange-traded fund means the index fund is listed on the stock exchange. This means that such a fund can be traded throughout the day, unlike mutual funds which trade only at the end of the trading day. This makes ETFs more liquid and accessible than mutual funds.
