How to Invest in Index Funds? Why Invest in Index Funds & Why not Invest in Index Funds
Index investing is a popular investment strategy involving the creation of portfolios around the stock indexes, a market average, or a benchmark. Since most fund managers fail to outperform in the market, the effective method to invest in diversified portfolios is to track the index while reducing the fees and costs.
Index investing is always used as an alternative to passive investing. There are many reasons why investors prefer investing in index funds. But, some believe that index funds come with higher risk, so they avoid investing in them. Let us find out how to invest in index funds and why and why not to invest in index funds.
How to Invest in Index Funds?
Unfortunately, India has not taken a kinship to index funds, but it will likely change in the coming years. Most diversified funds across India reflect index funds because a major part of those portfolios is invested in the index heavyweights. So, the investors will likely pay a high TER or Total Expense Ratio for minor return benefits. But index funds can help you overcome these challenges.
Index funds have not registered a great start in India for many reasons. It is because over 70-75 percent of the fund managers beat the index in India while it is just around 10-15 percent in America. So, when the indexing methodology turns tighter, and the flow of information gets efficient, the returns on passive and active funds will minimize to lower spread.
Just like you invest in other funds and stocks, you must invest in India index funds. Here are some of the steps to follow.
- Signup with some reliable and reputed broker
- Choose the index that you want to monitor or track
- Now choose the funds that track the index you have already selected
- The final step is to buy the shares through the index funds you have chosen
Why Should You Invest in Index Funds?
Since you know how to invest in index funds, it is time to know why you should invest in them in 2023.
- Index funds are likely to offer you a higher return in the long run because the two indexes, Sense and Nifty, have recently outperformed the market. The research confirms that Sensex had a base value of 100 in 1979, and in the past 40 years, it has offered 35-fold returns to investors. Similarly, Nifty had a base in 1995, and it has delivered 11-fold returns in two decades. It signifies that investors investing in index funds have made good returns in the past few years. Index funds can offer moderate to good returns because they come with lending firms’ stocks.
- Index funds are free from the prejudice of human discretion. It is the biggest challenge with most diversified equity funds. The fund managers are authorized with the element of discretion. As a result, the manager’s biases, conditioning, and experiences greatly differ in the fund’s investment strategy. These things are missing in the index funds. Since index funds are passive funds, they overcome the bias and allow tracking of the index.
- The cost of an index fund is comparatively low. Since the low rates allow the investors to save more while keep investing to earn higher rewards.
Why Must Investors Avoid Investing in Index Funds?
- The fund manager’s discretion is the best choice for active funds when asset distribution decisions are required to be taken. When the equity fund manager detects a highly volatile market, cash allocation is increased accordingly. But, index funds don’t have such flexibility because it is fully invested in the index at all points of time.
- Since index funds are free from the bias of fund managers, they are still at risk of experiencing tracking errors. It is the greatest extent to which the funds can’t track the index. The error occurs when liquidity provision, corporate actions, and index constituent alterations in index funds make it a highly risky investment.
- Index funds not only lack the expertise of fund managers but also lack the structured investment approach that managers of active funds deliver. In India, there are multiple alpha opportunities; hence, index funds usually fail to surpass the actively managed funds.
Investors are required to keep in mind that index funds are not great performers in India. But, it is a great investment approach that will likely become quite appealing in the upcoming years.
Investors know that index gives them a rapid and concise measure to appraise the market. So, study the index carefully if you want to know the market situation. Index funds offer a cost-effective way to invest, and they have the potential to bring good gains compared to fund managers and aids investors in achieving their financial goals.
Index funds are great investment choices for some investors. But some believe that index funds put excessive pressure on stocks in the large-car category. So, these funds must be monitored and guided by fund managers, which is lacking presently. But, with proper research on index funds, one can reveal that multiple respected investors give significance to such funds while urging others to move ahead and invest in index funds.