What are index funds?
Index funds are a compilation of funds that mimic a specific market Index. This is also a form of Mutual fund with a diverse portfolio. In the index funds comparison to any actively managed fund, this is the only similarity. If you are investing in the NIFTY 50 Index fund, for example, it will have a percentage of the companies listed under it. This reduces the risk of investment but, at the same time, may limit the portfolio return. It is a given fact that the market will eventually do better than any single fund in question. This makes it a great investment option for retirement benefit as the Index fund will ultimately grow in the long run.
Two features that make index funds stand out
If you check the Index funds comparison to any other fund, you will find it as a better option in many regards. Here are two of the best features.
- Lower fees than actively managed funds: Index fund is a passively managed fund, where the managers work only periodically. As it involves many securities, it charges only a benchmark index fee. The fund follows a weighted balance theorem, where the manager balances the percentage of securities if a single fund is weighing the total fund down. So, the expenses are much less compared to actively managed funds. While the index funds charge between 0.2% to 0.5% as expense cost, for actively managed funds, it can be around 1% to 2.5%.
- Strong Long-term return: In another Index fund comparison, it is found that the long-term return is much more for this particular fund. It is not at all possible for an index to go down to zero. Your investment is never going to die, for sure. In the long run, the index will eventually outperform its individual securities. If you are trying to invest as a part of your retirement plan, you can rest assured about the gain.
Statistics: Index Fund VS Large Cap Fund
(Img source: Paytm money)
The statistical analysis shows that except for 2018, the index funds comparison to large cap funds is skewed towards the later. However, 2018 saw a different trend and it is possible to keep seeing this in the long run. If you are investing 1 lakh in the market, say in a Nifty 50 index fund, for example, ICICI Prudential Nifty Index, the expense ratio is 0.10%, which is just Rs.100. If you now take an index funds comparison to a mutual fund, the expense ratio is 0.45%, which is Rs.450. So, you are actually investing Rs.350 less in the large-cap fund. Whatever the market return is, you stand to have a lower gain even if both the funds perform similarly. Again, this is for a single year, and in the long run, with weighing balance, the fund will outperform most of the large-cap funds.
Conclusion
Index funds are suitable for those looking for a lower expense ratio and are okay with lower portfolio gain as it minimizes risk. However, if you are looking for a short-term investment option, large cap funds may be beneficial with caution of high risk.
