Sometimes it becomes difficult to choose between vanilla ice cream and choco chips, and only you understand the level of anxiety you experience in the shop. But when it comes to investing, you will never want to feel the same level of anxiety. You definitely want to invest in the best suited for you.
The problem here is you have a wide variety of investment products available for you to fulfil the demand of the diversification level of the investors. Index and sectoral funds are two of these products that bring a lot of confusion to your mind while investing. You can make better decisions when you know what particular ice cream tastes like.
Key differences between the index and sectoral funds
The 3 key differences between the funds are as follows:
Sectoral funds are focused on a specific sector or industry, such as healthcare, technology, or energy. They invest in a concentrated portfolio of companies within that sector, intending to achieve high returns through capital appreciation.
On the other hand, index funds are passively managed funds that seek to replicate the performance of a broad market index, such as the Nifty 50. They hold a diversified portfolio of stocks that closely matches the composition of the underlying index.
Sectoral funds have the potential to outperform the broader market if their sector experiences strong growth or if the fund's investment manager makes wise investment decisions. However, they also have a higher potential to underperform if the sector experiences a downturn or if the manager makes poor investment decisions.
Index funds, by design, will typically deliver returns that closely mirror the overall market performance. The constituents of the index funds contain all the top-performing companies, which changes over time, which is why index funds tend to perform according to the country's overall economic condition.
Both funds hold different types of risks for the investors. In the case of a sectoral fund, investors tend to have more risk than index funds as the investment is concentrated in a particular industry which can face challenges due to changes in government policies, tax regulations, or sudden changes in raw material requirements. For example, the mobile phone industry is facing a downturn due to the shortage of semiconductors worldwide.
On the other hand, index funds include a diverse range of companies in different sectors. The downturn in one can set off another's uptrend. It is said to "never underestimate the power of index fund diversification," as experts and experienced financial analysts select constituents in indexes.
Sectoral and index funds can serve different investment goals and risk appetites. Sectoral funds may be appropriate for investors who want to focus on a specific industry or have a higher tolerance for risk.
In contrast, index funds can be suitable for those seeking broad market exposure and lower fees. It's important to carefully consider your investment goals, risk tolerance, and fees before choosing between these two types of funds.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com