Passive investment strategies are gaining traction throughout the world. It has been gaining popularity in India as well. More than 70 index funds are now available to investors nationwide. Passive funds are those that invest identically to an index they are monitoring.
Two common passive investments are index funds and exchange-traded funds (ETFs). Since ETFs may be traded on the stock market, just like stocks, a demat account is required to invest in them. When investing in an index fund, however, you purchase shares via the fund house just as you would with any other mutual fund, and you don’t need a demat or a trading account.
But how do you choose the right index fund for you? Let us take a look.
What are index funds?
Index Funds are a kind of passive mutual fund that attempts to replicate the performance of major market indexes. The Fund Manager does not take an active part in picking sectors and stocks to form the fund’s portfolio; instead, the Fund Manager merely invests in all the companies that are included in the index to be tracked. There is a high degree of similarity between the weightings assigned to the stocks in the fund and those set to each store in the index. This is passive investing, in which the fund manager builds the fund’s portfolio by simply copying the index and then works to keep the portfolio in sync with the index at all times.
If the balance of a share within the index shifts, the fund’s management must either purchase or sell stock units to maintain the weight of the cache within the portfolio at the same level as that of the index. Even though passive management is simpler to understand and implement, the fund’s returns may not always match the index’s because of tracking errors.
Choosing mutual funds
You may discover an alternative to each of the main active mutual fund categories by looking at the many index schemes that are now available. Some index funds focus on big caps, mid caps, and small caps. You may even discover a substitute for the multi-cap and Flexi Cap categories. Some exchange-traded funds (ETFs) follow sectoral indexes such as those for the information technology industry, the healthcare industry, the auto industry, and others. Because there is such a wide range to choose from, it is simple to depend on index funds for your financial planning.
It would be best to look at factors such as investment goals and risk appetite. For instance, if you are a conservative investor, you may choose large-cap index funds that invest in more stable companies.
You may also check the fund’s performance compared to the index it follows. This is because index funds could have a tracking error.
Errors in tracking may arise for several reasons, including the fact that it is never simple to hold the securities that make up the index in the same proportion and that doing so causes the fund to incur transaction fees. Despite being subject to tracking inaccuracy, Index funds are an excellent choice for those who do not like to assume the risk of investing in individual companies or mutual funds but are interested in gaining exposure to the whole market.