What Is Index Funds? Should We Invest In Them Now?

                           What are Index Funds?                     Should we invest in this now? Hello my dear friends, I hope you all are...

 

                        What are Index Funds?

                   Should we invest in this now?

Hello my dear friends, I hope you all are doing well. Today I will discuss what are the Index Funds, how it works, should we invest in it & is it a good option for low-risk taker investors? 

                         So let's start Investing With Ease.

➤ Before understating Index Funds we must know how an index is created with respective rules and regulations. By these indexes, we can understand the overall growth of a stock market of that country, so it plays a very vital role in the stock market.

⦿ What is Index in Stock Market?

An Index is basically a basket of companies in a standardized way. With this index, we can track the overall performance of the market, and also we can track the overall performance of a specific sector in the stock market.

There are various types of indexes for various types of assets, with them we can track those assets' overall performance. But here we only talk about the stock market indexes.

➤ An index can be made of large-cap companies, mid-cap companies, small-cap companies of that country. Also, it can indicate some specific sectors by them we can track those sectors.

Example: In India, the NIFTY50 index has a basket of 50 large-cap stocks from various sectors. Because the index covers various sectors of countries listed companies that's why we can get a brief idea of countries' overall stock market growth.

⦿ We also have to note that, in the index, there are various companies from various sectors but they are not equally weighted in the index. This weightage depends on index maker entities.

We will discuss the weightage factor while explaining the index funds.

⦿ What are Index Funds?

➤ Index funds are basically Mutual funds that follow the index in the exact same way(same companies with the same weightage). The mutual fund's companies create a mutual fund that follows the index, it can be of large-cap stocks, small-cap stocks, mid-cap stocks or it may follow the sector-wise index.

✦ There are many ETF's which follow the index, but we are not discussing this here.

➤ Index weightage: As I told you this depends on the index-making entity. Mostly in major indexes of the stock market, some companies cover all sectors. Let's take an example to better understand,

Example: For example here I am taking the NIFTY50 index, one of the most important indexes in the Indian stock market. It mainly uses the "Free Float Market Capitalization" method. And it rebalances the index semi-annually.

In NIFTY50: 

Finance-> 37.58% 

IT-> 18.01% 

Oil & Gas -> 11.39% 

Consumer Goods -> 11.05% which followed by Automobile, Metals, Pharma, Construction, Cement 7 cement products, Telecom, Power, Services, Fertilizer & pesticides.

★ There are more indexes like  BSE Sensex(India), Dow Jones(US), Nasdaq(US), Nikkei(Japan), etc.

🠞 Now I will discuss the pros and cons of Index Funds.

⦿ Pros:

1) The main reason why people invest in Index Funds is that it mainly follows the top companies of that nation(if we invest in large-cap index funds) which means it has the lowest volatility in the stock market and also in long run historically we see that it always go up.

2) If we invest in large-cap index funds then the investors have to bear less hustle because of low volatility. Investors who don't want to go through companies' charts or don't want to find good companies by themselves, they can easily invest here and have a relax.

For new investors who are new in the stock market, they can easily invest here because it already gives a basket of stocks and by them, they can learn fundamental analysis by themselves, then they can directly invest in stocks.

3) In index funds all the stocks in the basket are re-balanced regularly based on their past performance it may be quarterly or half-yearly. So if any stocks did not perform well they can be replaced with other good stocks.

4) Index Funds have the lowest expense ratio of any other mutual funds. In India, the Index Mutual funds' expense ratio varies between 0.09% to 0.30%. Because here fund managers don't have to do any heavy works like finding stocks, analyzing them, etc, they simply copy and paste the index stocks according to their weightage in funds.

5) This is the most important point, as an investor we want good yearly returns with low risk, so this can be a good choice for most of the investors because in the long run in developed countries like the US, UK their index gives 8 - 12% CAGR(compound annual growth rate) and countries like India, Indonesia these countries index gives 12 - 20% CAGR.

6) In most cases when we withdraw money from these funds the mutual funds' companies don't charge for early withdrawals. But it depends on the mutual fund companies.

⦿ Cons:

1) Index Funds are mainly called passive funds because of their returns compared to the stock market. Where good stocks can give us 15 - 20% yearly returns in a developed country and in developing countries a good stock can give us more than 20% yearly returns.

2) As I told you index funds are baskets of stocks it may be large-caps, mid-caps, or small-caps. When an index is made or rebalancing after a certain time period, it mainly considers past performance so if a stock did well in the last quarter then it can be added to an index, but past performance never assure future performance and who knows if the stock is already at its peak.

3) Continuing the last point, as mutual funds companies have to follow the index and its stocks, if mutual fund manager knows that which stocks are already there in the index and which are added in the index recently they not gonna perform well in next quarter, still they have to buy them because of the index. So sometimes they have to buy at high and sell them at low.

The mutual funds' managers have no power to change the stocks. Here is the difference between Active funds and Index funds.

4) As we all know mutual funds are taxed in two terms. So the index funds are also taxed in the same two terms 1) Short term capital gain tax, 2) Long term capital gain tax.

In India 15% tax on short-term capital gains if redeemed between 1 year, and 10% long-term capital gain tax if redeemed after 1 year of investing.

⦿ Conclusion:

Here we know about how indexes are made and how they work. We also know about how index funds work. After analyzing all the factors, pros, & cons we can say that these funds are good for those who don't want to research a lot or don't want to go deep inside the share market, those who just want a hustle free investment options with good yearly returns also without taking too much risk. This is also a good option for new investors who want to explore the market, without too much risk.

Overall if you are investing for the long term then Index Funds are a really good option to choose.

➤➤That is it for today guys. We will see you in the next blog, and I will try to post as fast as I can. Till then bye-bye😃😃.

Editor:  Sk Elaf Ahmed.