Index funds are mutual fund schemes that attempt to replicate the performance of their underlying indexes, such as Nifty or Sensex. They buy the securities in almost similar proportions to those included in the benchmark. For example, if you invest in a NIFTY 50 index fund, then your money would be invested into each of the 50 companies that make up that index.
These funds offer diversified exposure with lower management costs as you don’t need to pick individual stocks but instead buy into a much larger pool of securities. Therefore, you can get exposure to multiple stocks at once with minimal effort.
Investing in index funds offers several benefits, such as broad market exposure, low management costs, and the ability to track market performance. But there are different types of index mutual funds, each with its own unique characteristics, strategies, and risks.
Learning about these aspects can help guide you toward a more informed investment decision for your financial future.
Broad market index funds: Track a broad stock market index like NIFTY 500. These are typically considered low-risk investments since they provide exposure to a wide range of stocks without having to select individual stocks. The risk associated with this type of fund is the same as any other market index fund that is market risk.
Equal weight index funds: Attempt to provide equal exposure across all stocks in an index regardless of company size or sector. This helps reduce concentration risk since no single stock will make up too large a portion of your portfolio’s holdings and allows for better diversification across sectors and industries.
However, equal weighting can also lead to higher volatility if there is significant price movement among any one stock within your portfolio since it can have a large impact due to its equal weighting compared to other stocks in your mutual fund portfolio.
Market capitalization index funds: Determine the weightage of a security within the index based on a company’s market capitalization. These funds can be used to target specific market cap, focusing on certain sectors or industries within the overall market for greater returns. However, they also increase risk by concentrating investments in one area.
Factor-based or smart beta index funds: Track indexes that use factors such as momentum, value, quality, and volatility to determine which stocks are included in the portfolio and how much weight each one has relative to others in the same group. The risks associated with these funds include style drift (the fund deviating from its intended strategy) and liquidity risk (the inability to buy/sell positions quickly).
Sector-based index funds: Focus on stocks from certain sectors such as infrastructure, consumption, healthcare, or technology. However, sector-based investments can also be risky because they lack diversification across other industries or assets. This may result in losses if one particular sector underperforms due to macroeconomic conditions or other factors outside investor control.
Debt index funds: Replicate an underlying debt index such as target maturity funds (TMFs). These funds are generally used by investors who want exposure to fixed-income securities without having to manage their portfolio actively. However, debt index funds also carry some risks due to interest rate fluctuations or issuer default risk.
International index funds: Have a global scope as its focus and tries to track the performance of a similar benchmark index. However, these investments may be subject to currency risk or political instability risk.
Custom index funds: Tailored specifically for investors who have specific requirements for their portfolios’ composition. These funds require more research and analysis with the need to constantly monitor changes within different asset classes and external factors that could impact the desired outcome.
To wrap up
You can buy index funds just like other mutual funds investment plans. Simply create an account on mutual fund websites or apps and start investing in different types of index funds to diversify your portfolio with various assets and securities. Furthermore, the option to set up a systematic investment plan (SIP) ensures consistent investment over time, allowing you to leverage market fluctuations through rupee cost averaging and steadily grow your wealth.