Actively managed funds, as they are called, can better manage their performance during periods of volatility in the market. This is especially true of aggressive growth funds that invest in small-cap stocks that do not have proven credentials but exhibit good growth potential in the long run.
On the flip side, however, active mutual funds have higher expense ratios which cut into the rate at which investors earn returns. Fund managers may also suffer from biases, which may influence their investment decisions. Given the dwindling returns, investors are looking for a better alternative.
Enter Index FundAn Index is a group of securities that defines a particular market segment. In India, there are dedicated variants for both, the BSE Sensex or NSE Nifty. Unlike regular mutual funds, they do not seek to outperform the benchmark but match it. They are also called Exchange Traded Funds or Index Tracker Funds, for this reason.
Studies reveal that it is futile to try beating the benchmark every year. Warren Buffet himself has gone on record to say that investors are better off buying index funds as they “will do better on balance than what they will get if they to professionals”.
Advantages of Index Funds
- Low risk Index Funds are relatively low risk as they invest in the same bucket of stocks that are featured on the underlying index, which minimizes losses.
- Low operating costs As they merely track the performance of the index, they do not need active management. The expense ratios for index funds are generally under 1%, while those of regular mutual funds are around 1.5%.
- Broad diversification Index funds invest in the entire range of indexed securities as per their respective weightages. This lets investors benefit from a wide selection of assets across multiple industries and gives them the advantage of true portfolio diversification without additional costs.
This is a major bone of contention for investors wary about losing their earnings to high management fees. While mutual fund managers do take justifiable steps to increase returns, their consistency is temporary, in most cases.
The final verdictAs Index funds gain greater popularity in India, they may become the natural choice for investors. From the risk perspective, index funds can be a safe option, assuring steady returns. However, regular mutual funds thrive on taking calculated chances to give investors better than average returns, while index funds put a ceiling on it.
A smart investor would incorporate both, regular and indexed funds, in his arsenal to create wealth for the long term.
Explore our list of mutual funds here.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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