The basic concepts of Index Funds for beginners
We are sure that the name "Warren Buffett" rings a bell for all investors. His investment principles and strategies have stood the test of time and resulted in great wealth creation. So, when he strongly advocates Index Funds as a way to grow your capital, it is impossible to ignore it. Read on to know more about Index Funds and why they should be a part of your portfolio.
What are Index Funds?
Index Funds are mutual funds (or ETFs) that mimic a specific index's portfolio. These funds buy stocks in the same proportion as that of the particular index. Hence, theoretically, the index fund's performance would be in tandem with that of the underlying index, except minor differences which are known as tracking errors.
Key Features of Index Funds:
1: Diversification
These funds offer the benefit of diversification. With one purchase, you get access to a wide range of high-quality and diverse stocks.
2: Passive Funds
Index Funds are not actively managed funds. They passively follow or track the index's performance. The goal of these funds is not to outperform the benchmark or market but to match the selected index's results.
3: Low Expense Ratio
Index Funds are relatively less costly as compared to actively managed funds. This is due to the fact that the fund managers are not continuously scanning the market, re-aligning the portfolio or trading (buying or selling) stocks to generate higher returns.
4: Tracking Error
Index Funds have the same composition as that of the index. Hence, principally their performance should also be the same. However, often there is a small lag in the returns of the index fund. This is known as tracking error and could be due to numerous reasons such as expense ratio, corporate actions, cash flow management due to change in index constituents, redemptions, etc.
Tracking Error is the difference between the return generated by the index fund and that of the index being tracked. For instance, if the index gained 4% over a certain time period, while the index fund gained 3.8% in the same tenure, the tracking error is 0.2 percentage point for that period.
Smaller is the tracking error or difference, better it is for the fund. Many investors use this as a yardstick to select amongst various index funds.
5: Free of bias
In actively managed funds, fund managers play a critical role in the returns and performance. However, in index funds they have no say in the allocation or portfolio composition. Hence, these funds are completely devoid of any personal bias of the fund managers.
Who should invest in Index Funds
Index-based funds are ideal for investors who are looking out for a relatively safe, less volatile and diversified investment avenue that has the potential of wealth creation over a long investment horizon (minimum five years). Index Funds, since passively managed, are less volatile or aggressive in nature and hence suitable for investors who get overwhelmed by equity market fluctuations and prefer predictable returns.
Also, they are fit for inexperienced investors who do not have the time or knowledge for extensive investment or market research.
Top-Performing Index Funds
Selecting the right fund involves careful evaluation of a host of factors (Qualitative as well as Quantitative). These include returns over various timeframes, financial ratios, management stability, etc. Additionally, it is important to sync the investment decisions with your risk profile, financial goals and investment horizon.
Here is a list of the 15 top-performing Index Funds
1.HDFC Index Sensex Fund
2.Nippon India Index Sensex
3. UTI Nifty Index Fund
4. HDFC Index Fund Nifty 50 Plan
5. Tata Index Nifty Fund
6. ICICI Prudential Nifty Index Fund
7. Franklin India Index NSE Nifty Fund
8. Aditya Birla Sun Life Index Fund
9. ICICI Prudential Nifty Next 50 Index Fund
10. Axis Nifty 100 Index Fund
11. DSP Nifty Next 50 Index Fund
12. DSP Nifty 50 Index Fund
13. Motilal Oswal Nifty Midcap 150 Index Fund
14. Motilal Oswal Nifty 500 Fund
15. Motilal Oswal Nifty Smallcap 250 Index Fund
Final Words
Index Funds can be a great addition to your portfolio. After all, they come recommended by Mr Buffett himself.