How to Choose Best Index Funds in India for Investment in 2020
Over the past many years, Index funds have been considered one of the smartest investments to make. They’re affordable and well diversified, and tend to generate above average returns over long time, generally outperforming actively managed funds from the top investment firms. According to SEBI’s defintion, Index funds are open-ended schemes which replicate or track the stock market’s broader index.
It could be a great investment option for beginners as the risk is low and they come with wide range of variations. World renowned investor Warren Buffet claims that index fundsare a great investment option. So, how should one choose the right index fund in the Indian investment landscape? Let’s explore the options!
What is Index Fund?
An index fund, also known as passive mutual fund,is a kind of equity mutual fund which drafts its portfolio by tracking the composition of a standard market index such as the NIFTY 50 or the Sensex. Index fund invests in the stocks that constitute the benchmark index and in the similarproportionthat they are present in the index.
Hence, Index funds replicates certain indices like Nifty (NSE 50 Index) and Sensex (BSE Sensitive Index) at a minimal cost. These funds do not require a high level of active management of the fund. Hence, the expense ratio (fund managing cost charges) and other fees of index funds are lower thanothe actively managed funds and this makes them really cost-efficient.
Things That One Should Consider Before Investing in An Index Fund
Track the Expense Ratio:
Make sure to pick an index fund with low expense ratio to achieve higher returns. An index fund generally comes with an expense ratio of 0.5% or maybe even less, while the expense ratio for an actively managed fund can be anywhere between 1% to 2.5%. The difference exists as the fund manager does not need to draft any investment strategy for them.
Tracking error is the divergence between the price behavior of an index fund or a portfolio and the price behavior of the referential benchmark. Lower tracking error equals to better fund performance.Index funds passively keep track of the performance of the underlying benchmark. They are not centred around the goal of beating the benchmark. These funds just replicate the performance of the index. The returns generated might not touch the index because of tracking errors. An investor should shortlist funds with minimum tracking error before investing in an index fund.
Learn About AUM:
Higher AUM(Assets Under Management)equals to better advantage for the fund manager to tackle the liquidity issues. So, choose an index fund with higher AUM.
Learn About the Risk:
As index funds map an index, they are less prone to the volatility related to equity and individual stocks. Investing in Index funds could be an excellent choice to gain high returns. However, you might have to switch to actively managed funds if you witness a market slump. Index funds lose their value when the market falls down. It is suggested to invest in a mix of actively managed index funds.
Learn About Tax Benefits:
You earn some capital gains each time redeem your units of Index fund. The taxation rate would depend on the investment timeframe in index funds, the holding period. In case of one year holding period, the capital gain is known as STCG (Short Term Capital Gains) with a tax rate of 15%. However, in case of a holding period of more than a year, such capital gains are called LTCG (Long Term Capital Gain) and it comes with a tax rate of 10%.
Some of the best performing index funds in India are as follows:
· Birla Sun Life Index Fund
· Franklin India Index Fund – NSE Nifty Plan
· ICICI Prudential Nifty Next 50 Index Fund
· IDBI Nifty Index Fund
· Principal Index Fund – Midcap
· LIC MF Index Fund – Nifty
Things to Consider Before Purchasing an Index Fund
· As per data, well-managed active funds can beat the returns of passive funds such as index funds in the Indian landscape of investment.
· Tracking error is must for every index fund investor. It is the difference between an index fund return and the benchmark return.
· Index fund Investors may miss the benefit from the high growth potential of small and midcap companies as it invests only in mature companies that had already experienced growth in their past.
In the conclusion it can be said that ultimately the choice is as per individual’s risk tolerating ability, financial goals and timeline. However, it is always advisable not to rely only one type of fund, and to draft a portfolio that contains all kinds of funds to eliminate stress and accumulate decent returns in the long run.