The goal behind investing is to create wealth for the individual who is allocating their fund into the scheme. The schemes are generally investment tools that enableinvestors to invest money in the market. People generally choose to invest in the market instead of conservative schemes like FDs because allocating funds in market investing schemes helps in generating better returns. One of the best examples of investment schemes that help in investing in the market is mutual funds and their several variants. One of the many variants of mutual funds is index funds. But before learning what index funds are and whether to choose them over the other types of mutual funds, let’s learn what mutual funds are in general.
One of the most preferred investment options, an investment in mutual funds is regarded as relatively easier in comparison to buying stocks directly. Mutual fund investments are considered a stable choice because they help in cushioning the effect of risks through the process of diversification and, they don’t require regular monitoring of the movements of the share prices. But the question still may remain, “What are mutual funds?” Simply put, they are an investment tool in which money is pooled from a group of investors.Once enough money is collected in the fund, it is used to purchase different assetssuch as stocks, gold, money market instruments, and bonds. As stated earlier, mutual funds are not a monolith and every variant comes with its objectives. Depending on your investment objective, you will select a variant of the mutual fund, and after that, your funds will be allocated to the scheme. In case you are looking for an option that earns you big returns, you may opt for an equity fund and if you are looking for something safer, you may opt for something like debt or even an index fund.
One of the many types of mutual fund options that are available in the market, these funds are known for their feature of mimicking a benchmark index. NIFTY is an example ofa benchmark forindex funds.An index fund tries to replicate the composition of NIFTY and by doing that tries to generate similar returns. An example of passively managed funds,is index funds are known for havingthings like broad market exposure, a low portfolio turnover, and a low expense ratio when compared to other mutual funds that are actively managed. This type of mutual fund is suitable for long-term investors who don’t have the time to regularly monitor their investment portfolio. These schemes have one aim.It is to provide market returns to the investor at lower costs.
Index mutual funds are known for allocating funds to a specific set of securities such as the stocks that come with a particular index or benchmark. Conversely, mutual funds generally invest in stocks and other securities that are chosen by the fund manager chooses. The stocks selected by the fund manager managing a mutual fund portfolio may or may not be a part of a particular index. But they are chosen by the portfolio manager based on the fund’s objective.
These funds are known for being passively managed. For choosing the securities for the fund’s portfolio, the active participation of portfolio managers is not required. Conversely, a mutual fund scheme can be managed both actively and passively. In a mutual fund, the fund managers play an active role in picking the securities for the portfolio.
In contrast to mutual funds, index funds are less costly because there is no requirement for professionals like a team of analysts. Moreover, the expense ratio for index funds is considered to be lower and ranges between 0-2%. Comparatively, the expense ratio for mutual fundsis supposedly higher for mutual funds and may go up to 2.5%.
Based on the information above, it will look like index funds are better. However, that’s not the case. Under the index fund, the performance of a portfolio must not exceed that of the benchmark it is replicating.Mutual funds, on the other hand, don’t have such limitations. So, first, identify the investment objective before opting for a scheme.