Friday, Jul 01, 2022

Index Funds: A Good Starting Point For Beginners

Index funds are a good choice for new investors to get the feel of equity without taking undue risk.

An early bird gets worms and an early investor gets better returns. Various studies have suggested that equity has delivered higher inflation-adjusted returns than any other asset class over the longer horizon. The underlying message is the time horizon—the longer you remain invested in equities, the better the returns. However, for beginners, it could be a tad difficult to select the right stocks for investing in. Direct equity investment requires skill, knowledge, information and time. As a proxy for all this, one can use the mutual funds (MF) route, which is especially beneficial for beginners.

Selection Dilemma

Choosing the right MF scheme among a plethora of schemes offered by MFs across various categories such as Flexi, small-cap, mid-cap, large-cap, multi-cap, hybrid, thematic funds and many more, can be rather difficult for starters. Each such category has its own risk-return profile and understanding the structure and objective is essential before investing in them. The task of determining the category and schemes from the respective category can be overwhelming for beginners. That’s where index funds can come to your rescue.

“Index funds allow you to participate in equity without any hassle since you do not need to decide between sectors, investment styles, etc.,” says Suresh Sadagopan, founder of Ladder7 Financial Advisories, a Sebi-registered investment advisor.

Index funds are passively managed funds that invest in those securities that lie in their benchmark indices and in the same proportion. In India, we have two widely tracked indices, the NSE Nifty and the BSE Sensex. For instance, an index fund that tracks Nifty will invest in securities that are in the Nifty index and in the same proportion. Similarly, an index fund that tracks Sensex will invest in securities that lie in Sensex and in the same proportion.

Baby Steps

Beginners can look at index funds and use them as the starting point to getting exposure to equities. 

Index funds are a near-reflection of the market. Since their portfolio mirrors a broad-based index like the Sensex or Nifty, both in composition and weightage, they deliver returns that are in line with the market. So, if Sensex rises or falls 10 per cent in one year, an index fund linked to Sensex will show an almost identical rise or fall with a minor tracking error. 

If you are not investment savvy or don’t have the time and/or resource to track hundreds of actively managed MF schemes, an index fund is a right choice for you.