A Complete Guide On Index Investing

Every investor strives to make their portfolio outperform the market. However, this is not always the case with mutual fund investments. With the goal of outperforming the market, there are some investors who manage to stay in line with the curve. This is with the help of index funds. In the last 1-2 years, index funds have been getting increasingly popularand gaining similar traction in the country like that in the US.

Index mutual funds belong to a class of equity funds, but they are passively managed as they imitate the performance of the trending stock market index such as Nifty 50, S&P BSE Sensex. It is a passive investment strategy that offers diversification and has lower management expenses.One of the main advantages of index investing is it tends to outperform active management over a long time frame. Investors use a buy-and-hold strategy to replicate the performance of the equity or fixed income index.

Index investing helps to manage risk and gain adequate returns. For instance, if an index fund is replicatingthe NSE Nifty Index. The index fund can include equity and equity-related financial instruments along with bonds. Through index investing ensures that it invests all securities that the index tracks. The index fund tries to match the returns offered by the underlying index.

• Lower Expense Ratio Since index investing is passively managed, the expense ratio of the index fund is lower. The fund manager does not need to research or find stocks. The asset allocation remains more or less constant, and it would change only if there is a change in the asset allocation of the underlying asset.
• Well-established stocks The index funds belong to well-established companies, and they are not affected by the prevailing market conditions.The returns are consistent. There are fewer instances of losing on the entire investment.
• Tax-efficient Index funds are tax efficient. Unlike active mutual funds, investors do not need to switch the funds depending on the performance. This enables investors to save on taxes
• Ideal for conservative investors Index investing is an ideal investment avenue for conservative investors who are interested in the equity asset class.

• Lack of flexibility If the index fund is deriving negative returns due to unfavourable economic conditions, the fund managers do not get much flexibility to manage downsides.
• Less exposure to small and mid-caps There are very few indices that allow investors to select small to mid-cap funds. You get good exposure to large-cap mutual funds.

Investors who are looking for low-risk investment options with predictable returns can choose to invest in index funds. In the case of actively managed funds, fund managers can change the asset allocation in the portfolio based on the performance of the underlying assets. This brings a certain amount of risk to the portfolio. But in the case of index funds, such risks do not arise as these are passively managed. Returns from index investing are less as compared toactively managed equity funds

• Risk and returns They are less volatile than actively managed funds. The risks are low. The returns are generally good. If the funds are not performing well during the market slump, experts recommend you switch to actively managed equity funds. It is beneficial if you have a balanced equity portfolio consisting of both index and actively managed funds.
• Invest according to your investment plan Those investors with a long-term investment goal like retirement planning or wealth creation can opt for index funds. These funds experience fluctuations in the shortterm that average out in the long run.You can align your long-term investment goals with these investments and stay invested for as long as you can.
• Tax Being an equity fund, the index funds attract dividend distribution tax and capital gains tax.Once you redeem units from index funds, you earn capital gains that are subject to long-term or short-term taxation depending on your holding period. For holdings up to one year,i.e. short term investment,attractshort-term capital gain tax at the rate of 15%.If you have been holding the index funds for more than a year, this attracts a long-term capital gain tax of 10%.