Mutual Funds: Key benefits of having index funds in your MF portfolio

Index funds are recommended for individuals seeking to diversify their portfolios (Representational Image/Freepik)

An index fund is basically a mutual fund designed to mirror the composition and performance of a particular index on a stock exchange. Such a fund is best suited for risk-averse investors who want to get exposure to the equity market but at a lesser cost and minimum risk. Index funds are less volatile as compared to peers and offer decent returns in line with the performance of respective indices.

Though index funds don’t generate as much buzz in the markets at the time of the launch of NFOs (new fund offers), as is typically seen with other hybrid, large-cap, and mid-cap mutual funds, their biggest advantage lies in their stability compared to other funds.

Most index funds replicate stock indices such as Nifty50, Nifty Next50, Nifty100, and various sectoral indices. Unlike a portfolio manager selecting individual stocks, an index fund comprises a group of stocks mirroring the composition of the actual index. Their design aims to replicate the returns of the index they track.

Who should invest in index funds?

Index funds perform reasonably well and are best suited in well-organised markets. Also, you can easily track the fund’s performance based on how well the index is doing. These funds are convenient to invest as well. Further, because an index fund mirrors a particular stock index, it covers mostly all the key sectors of the economy and the relevant stock within each sector.

Index funds are recommended for individuals seeking to diversify their portfolios. Index funds don’t need to be actively managed by a fund manager the way other funds require, and that is the reason one pays less in fees for such funds.

What are the advantages of having an index fund in MF portfolio?

Portfolio Diversification:

Investing in index funds allows an investor to put his money into a group of stocks representing varied sectors, rather than investing in one stock here or there. For example, the Nifty50 has companies from the IT, pharma, power, FMCG, finance and other key sectors. Maintaining that level of diversity in their portfolio would be challenging for the average investor if the person were to pursue individual stocks.

Lower Administrative Fee:

Index funds, unlike other mutual funds or ETFs, do not require active management by fund managers, resulting in low or negligible administrative costs. Unlike other schemes where managers constantly track and adjust fund compositions, index funds operate without the need for ongoing management. This translates to lower fees for investors.

Steady Returns Over Long-Term

As data suggests, index funds provide steady returns year after year and have historically outperformed peers in various categories. For long-term investors, such consistent returns can contribute to substantial portfolio growth.

With hundreds and thousands of mutual funds available in the market, selecting the right one can be daunting. To simplify this process, investors can opt for index funds, avoiding the need for extensive research and analysis.