What are Index Funds? Which Index Fund Should You Invest In?

Many people seemed to be interested in Index funds these days and we believe that is a good thing. Index funds are the easiest and cheapest ways to passively invest in the stock market.

So let us understand what are Index funds and how you can invest in these funds.

What is an Index Fund?

An index fund is a type of a mutual fund that tracks any particular index. You must have heard of the Nifty 50 index. This index has the top 50 companies in the country. Now if you invest in a Nifty 50 index fund. What you are basically doing is that you are investing in the top 50 companies in the country. Here are some key things you need to know about Index funds.

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How Much is the Fee to Invest in Index Funds?

Low fees is one of the main reasons why investors opt for index funds. On average, the fees for most index funds is between 0.1 to 0.2 %. This is much lesser compared to the average 1% that is charged by most actively managed funds.

Also read: Here's How You Should Invest at Every Age

How Much Risk?

The second reason why investors opt for index funds is lower risk. When you choose an actively managed fund then your returns are dependent on the performance of your fund manager. However, when you invest in Nifty 50 then your returns depend on the performance of the markets. Since, Index funds are well diversified and invest in the top companies of the country the risk factor and volatility is relatively low.

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How Much Return?

Now coming to the main point. How much money can you make investing in Index funds? Well historically, Index funds have delivered about 12% return. If the markets continue to do well and India continues to remain on a decent growth trajectory then we can expect similar returns going forward as well.

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Which Index Fund Should I Invest in?

So which index fund should you invest in? Ideally you should choose the one with the lowest expense ratio since all the index funds should deliver the same returns. You can however choose which index you want to track. So like Nifty 50 tracks the top 50 companies. The nifty next 50 would track the biggest 50-100 companies in the country etc. If you just want to invest in just 1 index fund and are looking for a low risk opportunity you could go for a Nifty 50 index fund.

How do I Invest?

If you want to invest in an Index fund you can do that through many websites like Groww, ET Money etc. It’s a simple process and you can invest either a lump sum amount or through an SIP.

One interesting question that is often asked is ‘Should one invest in index funds if already invested in a large cap mutual fund?’

As we discussed, an index fund invests in all top 50 companies so a lot of the stocks in an index fund will be common with a large cap mutual fund. If you have already invested in a large cap fund and are happy with its performance then you can skip investing in an index fund otherwise there is no exact answer for this. It totally depends on the kind of risk you want to take.

An index fund on an average gives 12 % return.

A good large cap fund could deliver around 15% while a poor large cap fund could deliver around 10%.

If you want to take the risk of choosing for that extra 3% then you could go for large cap funds otherwise you should stick with index funds. Also remember that a large cap fund would charge 1-2% fees while an index fund would charge only 0.2% so unless your large cap fund performs significantly better, you will not make more money with them.

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