Index funds – Here’s why they’re a smart investment.

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Index funds, created by John Clifton Bogle almost 45 years ago as a way for everyday investors to compete with the pros. Index funds are a form of passive investing which is an investing technique that involves purchasing and keeping long-term assets, rather than performing regular trades to try to beat the market because they allow investors to buy a lot of stocks at once and hold them for the long term. We know the importance of investing in stocks to grow our wealth. But choosing the companies and industries that will deliver the best earnings growth is a real challenge. Competitive trends, management’s ability to execute on their plans and unpredictable events, make it very difficult to forecast results with success and consistency. Building a well-rounded portfolio of individual stocks is complex. Also it is difficult to actively buy and sell individuals securities and match the market’s performance. So to build a portfolio that is designed to grow and to get invested in many different companies and sectors it has to be well diversified.

At a period when financial markets have witnessed a dramatic downturn since the Covid-19 pandemic broke out and values of several securities reach their multi-year lows, investors have to pick stocks from certain firms that have a relatively solid balance sheet.

What will you do?

However, instead of focusing at specific firms, though, an investor will preferably participate in index funds that would have stocks of industry leaders around the board. Here, the easiest and low cost way to get invested in as many companies as possible is to invest in a mutual fund or an exchange traded fund(ETF). And an insightful solution to that is Index Investing which gives two important advantages that are: diversification and minimizing costs.  Index funds can give a broad exposure to the market. In fact, some are so broad that buying them means owing a tiny piece of almost every company in any country, with just one investment! 

Index funds have, proved to be a big success for retirement savers and other non-finance professionals, also for investors who are risk-averse and expect predictable returns as it does not require any extensive tracking. First of all, since you no longer pay someone to pick stocks for you, index funds appear to be less costly for investors than actively managed funds. In 2020, the average passive fund expense ratio is around 0.5% as compared to active managed funds having an expense ratio of 1% to @2.5%. These index fund investments are not controlled aggressively, so no plan is needed for the fund manager to devise. So, the disparity is in the expense ratio. So, Index Fund’s main USP is low expense ratio which generate comparatively higher returns on investment.

Index funds collect money from a group of investors and then buy individual stocks or other assets that form a particular index which helps to reduce the related costs that managers charge when opposed to other funds where someone is actively strategizing to include which investments and thus incurs low expenses. With an index fund, the mix of stocks — what’s known as its diversification — helps to minimize the portfolio’s related risk.

As the global business situation is volatile and the conditions are evolving quite quickly, the investors need to pick the index carefully. Ideally an individual would be invested in diversified funds such as Nifty or Sensex. When the Nifty is benchmarked with an index fund, the portfolio would make up the same 50 stocks as the benchmark. Individual investors who are not aware can hang on to investing funds for flexibility, liquidity and investment comfort. Some of the index funds to investment now are: LIC MF index Fund, ICICI Prudential Index Fund, HDFC Index Fund Nifty 50 Plan, UTI Nifty Index Fund and SBI Nifty Index Fund.

“Consistently buy an S&P 500 low-cost index fund,” Buffett said. “I think it’s the thing that makes the most sense practically all of the time.”

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