If you want to expose yourself to the market without taking on too much risk, you can consider doing so with index funds. In this form of investment, you purchase units in a fund that is constituted in such a way that it mimics a market index like the S&P BSE 500 or the NIFTY. Read on to find out what is index fund and how can it add to your wealth more effectively!
What is Index Fund?
The stock market index indicates the relative performance of the market. It is made up of stocks of select companies based on market capitalisation, type of industry or the company’s size. In index funds, shares of a particular index and used to build a portfolio by pooling money from several investors. It is similar to a mutual fund in this respect. The performance of your index funds will thus depend on the performance of the index.
The portfolios in index funds are mishandled and hence have lower expenditures. Also, the expense ratio is comparatively less.
Investing in Index Funds
Index funds are suitable for investors who are risk-averse and are looking for certainty in returns. The first step of this is to research the various funds. To diversify, you can invest in multiple index funds that track separate indices. You can combine a bond total market index fund, a domestic total market index fund, and an international total market index fund, to reap maximum benefits. You have to consider factors like your age, present financial situation, and financial goals etc. before investing.
Advantages of Index Funds
- They are less prone to equity-related volatility. This makes them low-risk options that guarantee expected returns.
- The expense ratio is less than 0.5%. This makes them less expensive investments.
- Although index funds face fluctuations for shorter terms, they can gain a return of 10% to 12% for an investment of 7 years or more.
- They perform much better than actively managed mutual funds in the long run.
- You can invest in index funds even if you are not a pro at investments.
- The sales commission and operating expense you pay the brokerage is minimum.
- You do not need to choose between winning and losing stocks as index funds include all the investments that make up the index.
Disadvantages of Index Funds
- The objective of index funds is mimicking the performance of an index. Therefore, it makes no effort to beat the benchmark index.
- Investing in index funds is taxable, and the tax depends on the duration of the investment. Long-term investments offer better tax saving than short-term investments.
If you are investing to expand your wealth or save for your retirement, index funds can prove very profitable. Like all forms of investments, the chances of losing money are real. However, since you are investing for the long haul, the risks are significantly obliterated, and you can expect large returns in the end.
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