How Do Index Funds Work?
According to NSE data collected for the financial year 2021, the number of individual investors in the stock markets reportedly increased by a whopping 142 lakh! Indian investors have now found ways to set aside their risk-related fears and take the plunge.
Avenues like index funds have genuinely helped this cause. Investing in them does not involve the assessment of individual stocks. Neither does one need high-end stock market investment advice. How do these funds work? What makes them hot picks for beginners? We find some answers here.
What Exactly are Index Funds?
An Index Fund is an equity fund that uses a benchmark index. When you invest in one such fund, the money is used to make a diversified investment among all the companies that the index comprises. Simply put, your investment is linked to the performances of many companies instead of just one!
The objective of index funds is to reflect the holdings of the particular index they are tracking. Therefore, they are diversified, and they also incorporate lower risks in comparison to individual share or stock holdings. This assures peace of mind, especially for those with a low-risk appetite.
It is important to remember however that, future returns are never guaranteed even with the best index funds. Just like any other investment made in the stock market, even the most renowned index funds in India may not be able to live up to the expectations when it comes to future gains and is always subject to market fluctuations.
Index Investing Involves Passive Investing
Index investing is different from mutual fund investing. When you choose index funds to invest in, you are not required to manage the bonds or stocks the fund comprises, actively. After all, the fund is only mirroring a specific index. This is why investing in these funds is more manageable especially if you are a novice in stock market trading.
Mutual funds, on the other hand, involve active management by managers who pick the investment options for you. The objective here is to defeat the market. With index investing, the goal is only to remain at par. Also, since index investing does not need active human management, the management costs or “expense ratios” are much lower. This can help you in saving a significant amount of money, especially in the long term!
Getting Started with Index Funding
Begin by opening a brokerage account. Once it has been successfully opened, fund it and proceed to invest in top index funds with comparatively lower index ratios. You can choose from funds that track international stocks or even government bonds for that matter!
It is important to keep in mind that index funds are taxed when redeemed as a capital gain. Since it is an equity fund, the holding period is 1 year. Long-term capital gain arises only if you hold the fund units beyond 12 months. Any LTCG up to 1 Lakh is tax exempt.