This is a type of mutual fund that has seen a rising popularity among investors in the recent past. Thus, index funds help investors get exposure and diversification across the Indian stock market as the stock market expands. Holding index funds can also be beneficial in many ways that would be attractive to most people. Below are the 5 advantages of investing in index funds that have put them among the most popular investment instruments to build wealth in the long run.
- Low Costs
Index funds are designed to mirror a specific market index as opposed to attempting to achieve an alpha. This passive investment strategy results in low operating expenses as compared to the actively managed mutual funds. In index funds, companies do not have to employ expensive research teams and high portfolio manager salaries which are costs that are incurred by actively managed fund companies. They usually accumulate over time especially when compounded by the number of times rate changes occur. In a long term investment, say 20 or 30 years, the difference in fee structure means that index funds outperform the actively managed mutual funds across most market conditions.
- Diversification
The index funds also offer the investors of 5paisa with the best opportunity for diversification in terms of sectors, market capitalization and individual stocks. For instance, an index fund replicating broader market index like Nifty 50 or Sensex will have representation across sectors such as financials, IT, consumer goods, pharmaceuticals, etc. The kind of exposure provided in one fund can only be gotten by investing in a pool of many stocks across various industries.
- Long-Term Returns
It should be noted that past performance is not indicative of future results, however index funds have had good long term returns that align with the index they are tracking. Instead, indexing accepts market returns overall for sectors and according to market capitalization without aiming at loading up on sectors or even stocks that may have outperformed considerably.
- Easy & Convenient
Index funds are also considered to be more convenient to investors than choosing individual stocks from various sectors and industries. It is not a matter of choosing amongst thousands of listed stocks but more of selecting an index to invest in such as Nifty 50, Sensex, S&P BSE 100 or S&P BSE Midcap.
Index funds also involve lower levels of research and analysis compared to individual stocks or actively managed mutual funds. Since index funds invest in benchmark indexes themselves, it is not necessary to examine the earnings reports or the management changes of the constituent companies. The portfolio manager is in charge of adding new stocks to the index under tracking or removing out the stocks that do not meet the criteria to be included in the index.
- The Underlying Holdings Disclosure
Another advantage accruing from the usage of index funds is that these offer a high level of portfolio and holding identification. As index funds are designed to replicate benchmark indexes, the investor is aware of which stocks and industries are being invested in and their approximate proportions. This makes it easier to determine things like market cap and sector exposure rather than it being some sort of black box.
Conclusion
Index funds have several clear advantages making them one of the most solid instruments for long-term savings for many investors. In this way index funds and arbitrage funds make investment easy, affordable, arbitrage funds, diverse, and easily accessible across the sectors, by offering returns from stock markets. Long-term buy-and-hold investors seeking to create wealth over 10, 20 or even 30 years should consider including index funds for core equity exposure based on targeted indexes and risk levels.