Investing isn’t about simply putting your money in the stock market and hoping for the best. It is a strategic approach to growing your wealth over time. Hence, understanding which investment option is right for you is essential. Some investors prefer an active approach that involves carefully selecting and investing in individual stocks or assets that they expect to perform well, while others prefer passive investing with index funds.
Index funds are passive mutual funds where the fund manager does not aim to outperform or beat its index or benchmark. Instead, the objective is to simply replicate or mirror the performance of a given market index, be it Nifty or Sensex.
From diversification and cost-effectiveness to impartiality and transparency, index funds come with certain advantages that can help to build long-term wealth. On that note, here are four reasons why investing in index funds should be part of your financial strategy.
Low expense ratio and fees
Index funds do not involve extensive trading, active management of assets, and constant monitoring. This leads to lower costs as the fund manager is only required to passively track a particular market index with not much active buying or selling involved. As a result, more of your investment capital is allocated towards creating returns.
You can invest in index funds systematically with small contributions
By leveraging Systematic Investment Plans (SIPs) for index funds, you can take advantage of low entry points and spread out your investments over time. Many experts agree that this is the ideal way to build wealth because it minimises the risk by eliminating market timing and allows investors to capitalise on market fluctuations by purchasing more units when prices are low, thus taking advantage of rupee-cost averaging.
To maximise the potential of SIP index funds, it is advisable to use an online SIP calculator to compare and calculate different plans and choose the one offering competitive returns.
No bias or impartial investing
Index mutual funds offer a bias-free approach to portfolio diversification. With an automated and law-based process, fund managers rely on the predetermined ratios of securities, thereby eliminating any potential human influence that may introduce bias into the decision-making process.
As an investor, you benefit from this unbiased approach by effectively ‘trading’ on the overall performance of a given market or sector as opposed to individual stocks or bonds. This helps you reduce your risk exposure while also taking advantage of the potential opportunities provided by a growing market.
Broad market exposure and diversification
By investing in an index fund, you are investing in every stock included in the particular stock index being tracked by the fund. This means that if one stock’s price drops, there is still potential for other stocks included in the portfolio to offset such losses.
For example: If you invest in aNifty 50 index fund, you will get exposure to 50 securities from various industries, from financial services to pharmaceuticals. This allows for greater diversification than you could have obtained by investing in individual stocks, thus mitigating risk and providing decent returns over time.
From eliminating market timing and the need to select individual stocks to low expense ratio and diversification, there are several reasons why including index funds in your portfolio can be worthwhile. Moreover, you can invest in index funds instantly, as there are many online brokerages and financial institutions that offer them.
However, as any responsible investor, you should also compare different funds, their past performance, tracking error, and expense ratio before choosing an index mutual fund that aligns with your goals, risk appetite, and financial needs.