Considering an investment in equities but aiming to avoid the risks associated with individual stock selection? Index funds, such as Nifty or Sensex index funds, might be a suitable choice.
These funds mitigate portfolio risk by diversifying investments across multiple stocks spanning different sectors. The advantage lies in the protection of your portfolio from the underperformance of any single stock, as the overall index is likely to have performing stocks compensating for the laggards.
Unlike actively managed funds, index funds eliminate the risk associated with fund managers making incorrect stock selections. If stability and consistency in returns during upward market trends are your goals, index funds align well with such objectives.
For those seeking higher risk and potential returns, researching equity funds that may outperform the overall market could be a viable option.
Various types of index funds are available in India, catering to different investment preferences:
- Nifty Index Funds: These funds mirror the Nifty 50 index’s performance, providing exposure to the top 50 companies listed on the National Stock Exchange.
- Sensex Index Funds: These funds replicate the performance of the Sensex 30, allowing investors to participate in the top 30 companies listed on the Bombay Stock Exchange.
- Sectoral Index Funds: Tailored to specific sectors like banking, technology, or healthcare, these funds track the performance of companies within the chosen sector.
For instance, the Motilal Oswal Nifty Bank Index Fund is a sectoral index fund linked to the Nifty Bank index.
Benefits of investing in Index Funds include
– Passively Managed: Index funds follow a passive investment strategy.
– Low Expense Ratio: Index funds typically have lower expense ratios compared to actively managed funds.
– Absence of Human Bias: These funds are free from individual human biases.
Investors aiming for long-term wealth accumulation may find index funds appealing due to their low expense ratios and adherence to fixed investment portfolios, mirroring the indices.
A list of top index funds in India is available on the NSE website.
Presently, the top 5 index funds in India, based on the past 5 years’ annualized returns, are as follows
- Tata Nifty 50 Index Fund – Direct Plan
- UTI Nifty 50 Index Fund
- Nippon India Index Fund – Nifty 50 Plan
- ICICI Prudential Nifty 50 Index Fund
- BANDHAN Nifty 50 Index Fund
To embark on investing in index funds, follow these steps:
Step 1 – Choose an Investment Platform
Consider these reputable index fund investment platforms in India:
– Zerodha Coin
– Groww
– Scripbox
– FundsIndia
– IND Money
If you already possess a demat and trading account, your broker may offer index fund investment facilities. Brokers like Zerodha, Motilal Oswal, and ICICI Direct provide direct investment in index funds through their platforms.
Step 2 – Pick the Right Index Fund
Compare the top 5 index funds based on factors like 5-year returns, expense ratio, and Assets Under Management (AUM):
Bandhan Nifty 50 Index Fund
– 5 Year Returns: 12.42%
– Expense Ratio: 0.10
– AUM: ₹720.30 Crores
UTI Nifty 50 Index Fund
– 5 Year Returns: 12.28%
– Expense Ratio: 0.20
– AUM: ₹9965.39 Crores
Tata Nifty 50 Index Fund
– 5 Year Returns: 12.27%
– Expense Ratio: 0.16
– AUM: ₹385.64 Crores
ICICI Prudential Nifty 50 Index Fund
– 5 Year Returns: 12.20%
– Expense Ratio: 0.16
– AUM: ₹4176.69 Crores
Nippon India Index Fund
– 5 Year Returns: 12.19%
– Expense Ratio: 0.20
– AUM: ₹753.55 Crores
Currently, “Bandhan Nifty 50 Index Fund” boasts the highest 12.42% returns, the lowest expense ratio of 0.10, and a decent fund size of ₹720 Crores.
Step 3 – Index Fund Investment
If using Zerodha Coin, type the name of the desired index fund in the top-right search option. However, you can utilize any mutual fund investment platform for the investment process.
Investors have the option to choose between a single Lumpsum payment or a monthly Systematic Investment Plan (SIP) when investing in index funds. Monthly SIP is often favored by salaried individuals seeking to invest smaller amounts regularly, while Lumpsum investments may be more suitable for small business owners anticipating one or two significant inflows per year.
Upon clicking the “Buy” option, a pop-up form will appear. Upon completion, clicking the “Buy now” button directs you to the payment page. Follow the instructions and provide the One-Time Password (OTP) to facilitate fund transfer. The units of the purchased index fund will be credited to your account the following day (T+1 day) after 7 PM.
Despite the advantages of index funds, there are some drawbacks to consider:
Drawbacks of Investing in Index Funds
- Risk of Tracking Error
Tracking Error can occur due to minor discrepancies in the composition of the index fund, ranging from 0.03% to 0.16%. Changes in index share weights and corporate actions, like bonus share issues, contribute to tracking errors, resulting in a slightly different return compared to the benchmark index.
- Lack of Flexibility for Fund Managers
Index funds must remain fully invested at all times, even during extreme market fluctuations. Fund managers lack the flexibility to hold cash in bearish markets or increase allocations to high-beta stocks in bullish markets.
- Potential Underperformance
In India’s developing stock market, active mutual funds can identify undervalued stocks to generate higher returns by taking additional risks. In contrast, index funds simply mirror the underlying benchmark, limiting returns to those of the indices. Investors seeking high-risk, high-return investments may find index funds less suitable.
Tax Implications of Investing in an Index Fund
Index funds are subject to capital gains tax upon selling units. Short-term capital gains (holding less than 12 months) are taxed according to the applicable slab rate. Long-term capital gains (holding more than 12 months) incur a 10% tax on gains exceeding Rs. 1 Lac.
Investors should consider these factors when deciding to invest in index funds.
