Index funds are cheaper to manage than actively managed mutual funds because they have low expense ratios thus cost effective to investors. While past performance does not necessarily predict future results, index funds have had higher long-term returns than most actively managed large-cap mutual funds. Here are 5 handy tips to help you choose the best index funds to invest in:Here are 5 handy tips to help you choose the best index funds to invest in:
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Choose index investment vehicles
Long-standing stock market indices, such as NIFTY 50 and SENSEX 30, represent the performance of leading large-cap stocks. Index funds that track such established benchmarks as these, do not only offer fairly steady returns over long-term but also are not that volatile during bear phases. There are several index funds available in the market based on bluechip indices such as UTI Nifty Index Fund, HDFC Index Fund Sensex Plan, ICICI Prudential Nifty Index Fund, among others. In this case, retail investors are better off selecting schemes that track well-known indices that reflect the overall market.
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Size of the fund and assets
The best-suited index funds are those which exhibit low tracking errors – that is, the difference in performance between the fund and the index it targets. One of the key variables that determine tracking error is the size of the fund in terms of the total value of assets managed (AUM). An index fund should have more than Rs 500-1000 crore of assets under its management to achieve adequate diversification and index replication. Small-sized index funds indicate that tracking error tends to be high, and this results in variations in performance as compared to the benchmark returns.
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Avoid high expense ratios
This helps to avoid the dilution of wealth over long investment periods of 10-20 years. Therefore, it is crucial for retail investors to pay attention to the expense ratios when comparing the index funds.
For instance, UTI Nifty Index and HDFC Index Sensex funds have very low expense rates that are approximately 0. 1 percent, which is quite low. On this Rs 1 lakh investment compounded at 12% for 20 years, it would amount to fees paid of approximately Rs 14,500 to the index fund; as opposed to an actively managed fund charging 1. 5% fees and thus costing more than approximately Rs 72,300. Since low-cost index funds are the best for utilizing the power of compounding, better over the long-term.
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Understand portfolio concentration
Index funds therefore operate under the principle of diversification and low costs. Since they replicate major indices that range from 30-100 stocks, the investors get a return on many stocks instead of concentrating on a few. Nonetheless, after the investment in index funds, investors should consider the overall concentration level of their portfolio. Ensure that the selected index fund does not contain the similar top 5-6 stocks to those you already possess.
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Monitor the performance of various index funds
It is important to note that past returns do not determine future results, however studying long term index fund returns is valuable. The ideal holding period for index funds should be 5-10 years or more. Analyzing their performance over 10-15 years makes it possible to determine whether there is a consistency in the provision of efficient tracking of underlying benchmark indices across market cycles. Using indexes enhances the analysis by preferring index funds which have completed over 10 years since inception.
Conclusion
It goes without saying that index fund as well as arbitrage funds has now firmly established themselves as one of the most preferred investment tools for retail equity investors of 5paisa in India at present. Through constant equity returns, they enable wealth creation within a transparent and low-cost environment. However, index funds are not a one shoe fits all investment option available for investors. In considering which index funds to invest in, retail investors must consider several factors depending on their risk tolerance, investment time horizon, and portfolio requirements.