How to make a wise investment in index funds
Just investing your income in the market is not enough. It is important for you to identify the right investment plan to earn the optimal returns from your fund allocation. Choosing the right investment plan will help you in accumulating wealth in the future whereas the wrong plan will result in losses for you in the present and will also fail in creating wealth for the future. Therefore, it is important to invest in the right plan.
While investing, you will find that there are several investment tools and one of them is mutual funds. They are an investment product that pools money from a group of investors to purchase different securities like stocks, bonds, gold and money market instruments. However, mutual funds are not a monolith and there are numerous types of mutual funds available in the market based on your risk appetite. One such option is index funds.
What is an index fund?
Simply put, they are a type of mutual fund that is known for imitating the portfolio of an index. Passively managed, the main objective of index funds is to track and emulate the performance of a popular stock market index like S&P BSE Sensex and NSE Nifty 50. The asset allocation of an index fund would be the same as that of its underlying index. In an index mutual fund, your money is pooled with other investors. Once enough funds are accumulated, the fund manager allocates them to instruments that make up the index such as stocks and bonds. While the fund may or may not invest in every component of an index, the main aim is to get an appropriate sample of every piece in order to effectively track the index performance over time.
What are its features?
- They follow a passive investment strategy
- They have lower expenses and fees. This is appealing to investors
- They seek to match the risk and the income of the market. It is done based on the theory that in the long term, the market will outperform any single investment.
- They are a portfolio of stocks or bonds that are designed to mimic the composition and performance of a financial market index.
What are the tips for a wise investment choice in index funds?
If you want the make the best of your index funds, please do the following things:
- Choose to invest in mid-cap businesses:
In simple words, mid-cap businesses are companies that rank between 101 and 250 by their full market capitalisation. Investors here need to brace for some risks while investing in these organisations as they are yet to prove themselves as big businesses. While it is true that risks are involved once you opt to invest in these firms, they do have the potential to emerge as the alphas of the market and thereby generate significant returns in the future.
- Please go for the right investment option:
While opting to invest in mutual funds, you will come across two investment options namely lumpsum investment and systematic investment plan or SIP. Under lump-sum investment, you pay your share of funds at one time. SIP on the other hand is a deduction from your account at regular intervals. You could opt for a lump-sum investment if you have the money at your hand. However, if you don’t, you could opt for a SIP.
- Using the power of passive investing:
Passive investing is a long-term strategy for generating wealth by buying securities mirroring the market indices and holding them long term. This strategy can help in lowering the risk because you’re investing in a mix of asset classes and industries and not an individual stock. The main goal of this strategy is to help you to accumulate wealth gradually. Those using this strategy attempt to replicate the market performance by constructing well-diversified portfolios of single stocks. A major advantage is that this strategy doesn’t usually result in a massive capital gains tax for the investor.
Index funds generally come with blue-chip stocks i.e., the stocks of well-established companies with an excellent track record. Therefore, these stocks are less susceptible to market fluctuations and hence are known for offering stability.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.