Index funds are a type of such fund that replicates a specific index in their investment portfolio so that the investors may aim to generate similar kind of returns as being generated by the index it is replicating. The indices which might Will be tracked by such kinds of index funds may include S&P BSE Senses, etc.
as such, index funds is suitable for investors with longer investment horizon who are comfortable with the returns generated by the broader market indices, basically instead of aiming to outperform the market. Since the portfolio of the index funds must be the same as the composition of the underlying index, these funds will not be able to operate any alpha in any market.
We can say in simple words index funds are a type of mutual fund. A mutual fund is a kind of a bunch of money owned by a bunch of people. back in the day, mostly all types of mutual funds were actively managed. It means a smart manager was paid to take all the money, and buy a bunch of stocks with it at his discretion.
The people who are interested to invest would put some money into the mutual fund and they would put some money into the mutual fund and they would get a bit of all the stocks the confident guy concludes to buy. It was a nice way to diversify your portfolio without having to do all the researches and trading yourself.
Index funds are a type of preselected collection of hundreds or thousands of stocks, bonds. These are being designed to mimic a given market or index.
An index fund is a type of passive investment vehicle with a portfolio of stocks designed to imitate the portfolio of a financial market index.it is an investment strategy with relatively little trading, few brokerages, etc. these funds provide balanced, risk-managed returns with possibly better long-term results.
How does an index fund work?
Index fund works on a passive investment strategy, in which the fund manager doesn’t have any type of flexibility to choose stock or decide their proportion in the portfolio. For example, if an index has 5% weight for company A and 8% for B, the fund manager doesn’t enjoy any type of liberty to invest in company C or even invest 10% in company A. an index fund must keep at least 95% of the portfolio invested in similar composition as that of the underlying index. Any fresh redemption flows in an index fund are suitably liquidated to maintain the index composition.
However, the manager of the fund must come on track with the underlying index for any changes over the period and make suitable and preferable changes in the fund portfolio. AS such, whenever the index composition changes, the fund manager must rebalance the portfolio according to the modified index composition. Given a minimal role of the fund management team in devising the investment portfolio, such funds also carry a low (TER) Total expense ratio.
Investing in index funds
One can invest in index funds in the kind of the same manner as investing in another type of mutual fund scheme. As such, one can invest by submitting application forms physically in the official points of acceptance for the fund house or by visiting the website of the fund house.
Advantages of Index funds
- It is a disciplined investment approach.
- It provides low brokerage costs and expenses ratios.
- It has a well-diversified portfolio.
- It is easy to understand and has high liquidity.
- It is safer in investment options and professionally managed.
- fewer fees than actively managed funds.
Disadvantages of Index funds
- It is having a lack of portfolio customization.
- Do not offer much exposure to small and mid-cap stocks.
- It is not aggressively distributed.
- It is having too much dependence on the well-performing stock.
- Small, medium, and multi-cap funds have beaten benchmarks indices.
- I am not flexible and have limited gains.
5 Types of a portfolio we can add to our portfolio
The index fund is a type of portfolio of stock that replicates a particular index. Compared to a mutual fund, an index fund is available at a low cost.
Here are the 5 types of index funds available in the market;
Broad market index funds
These invest in top stocks from different types of sectors like technologies and finance. Thanks to this diversification, your overall risk is reduced.
Market capitalization index funds
These compromised stocks weighed based on their market capitalization. Hence, the risk and returns of the fund depend on the market cap of the constituent stocks.
Earnings based index funds
These are designed based on the profits of a company, which are linked with 2 indices; growth and value. While growth index funds invest in stocks expected to generate profits quicker than the overall market, value index funds consist of stocks that trade at a price lower than the company’s earnings.
Bond based index funds
This investment is in a portfolio of bonds having a fixed maturity. Such funds are suitable if you are looking to invest in low–risk avenues to enjoy the safety of your money.
International index funds
These give exposure to high–growth companies outside India. It’s a feasible option if you want to enjoy the advantage of the emerging international markets.
In conclusion, After a deep study on the topic of index funds. It covers the objectives which I have set (complete information of index funds, how it works, what is the process of investing in it, advantages and disadvantages of it and its types.) I observed that index funds are very important for investing and it is a type of mutual fund. The main thing is that it is always better for a beginner to start his/her investment journey with index funds. After the index investment, an investor can move up the hierarchy with active mutual funds and then direct equity investments depending on his/her risk tolerance.
You may refer to this video if you want the explanation in Hindi