Instead of investing in a diversified portfolio while spending time analysing the micro and macro economy as well, why don't we invest in index funds which already have a portfolio of multiple sector companies?
Before considering an index fund as your investment avenue, let us understand what index funds are:
Index funds are the bucket or portfolio of stocks which mimic the performance of a financial market index such as the Nifty or Sensex.
There are mainly two ways of managing funds; actively and passively.
In the case of active fund management, the fund manager buys and sells equity frequently in the short term.
On the contrary, passive fund managers concentrate on stocks that are worthy enough to hold for a longer period of time. Index funds fall under the passive fund management category, as the fund manager will track the returns of the stocks according to a particular index.
Index funds are one of the smartest ways to diversify your portfolio to achieve long-term growth. It is simple to invest as it requires less investment research and is cost-efficient which will help you grow your money.
Let's discuss in detail why you should invest in index funds
The epitome of passive investment is index funds. The index fund's portfolio mix becomes much simpler and more predictable because it is only pegged to the index's members.
You do not have to track every company's performance as the index won't likely be affected by a single company's internal mismanagement. Hence, it is more likely to establish predictability in getting returns.
One of their main benefits is that index funds substantially overcome human bias. The considerable preference granted to fund managers with diversified equity funds is a problem. As a result, the fund's investing strategy is influenced by the fund manager's conditioning, prejudices, and past experiences. Being a passive fund, the index fund only follows the index, making it more transparent.
Reduced the tax liabilities
In the case of Index Funds, unlike active funds, you do not have to pay tax as a short-term capital gain of @15% (plus surcharge and cess).
Since index funds are passively managed, fund managers don't sell or buy frequently. You will need to pay long-term capital gain in which you will get the benefit indexation.
Low expense ratio and fees
An effective staff of research analysts is not necessary to assist fund managers in selecting the best companies because an index fund mirrors its underlying benchmark. Additionally, there is no stock trading going on. All of these elements contribute to an index fund's reduced managing costs.
Covers a large portion of the market
To guarantee that the portfolio is diversified across all industries and stocks, you should invest in a ratio similar to that of an index. As a result, an investor can use a single index fund to capture the likely returns on the broader sector of the market. If you choose to invest in the Nifty index fund, you will have access to 50 securities distributed over 13 different industries, from pharmaceuticals to financial services.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com