Index funds can be a good starting point for beginners to build a robust mutual fund portfolio.
What if you want to hold a mutual fund portfolio that is able to generate returns almost in line with the stock market? Welcome to the world of passive funds! Investing in index funds is the solution as they are passive funds with underlying stocks as represented in the index that it tracks. It means, by investing in an index fund, you end up holding stocks in the same proportion as held in the index.
By investing in index funds, you essentially stay away from the funds that are managed by a fund manager. The role of a fund manager in selecting the stock or an industry and even the allocation across them is totally absent in index funds.
The returns of an index fund mirrors the returns generated by the index that the fund tracks. In a way, index funds can be a good starting point for beginners to build a strong mutual fund portfolio.
But remember, the active funds which have a fund manager to manage the scheme may outperform over the long term, however, an underperformance in such active funds cannot be ruled out either.
Here we look at some of the NSE indices which are available to investors through index mutual funds.
Nifty 50 Fund: The most common and a popular Nifty index is the Nifty 50 index which is a diversified 50 stock index accounting for 13 sectors of the economy. The index funds tracking Nifty 50 will have the same set of stocks like that of Nifty 50 in the same allocation and exposure. You can choose a Nifty 50 index fund from any fund house and start investing in it.
Nifty 50 Equal Weight Index Fund: Then, there is the Nifty 50 Equal Weight index that represents an alternative weighting strategy to its market capitalization based parent index, the Nifty 50 Index. The index includes the same companies as its parent index, however, weighted equally. The Nifty Next 50 Index represents 50 companies from Nifty 100 after excluding the Nifty 50 companies.
Other Index Funds: Similarly, Nifty Midcap 150 Index captures the movement and is a benchmark of the midcap segment of the market and the Smallcap 50 index intends to measure the performance of small market capitalization companies. Further, there are other such index funds based on market capitalisation, themes, sectors etc.
Rather than picking individual stocks of the various indices – large-cap, mid-cap or small cap – you can take exposure in one or more of such index funds through a single investment. You can ask your financial advisor or visit the fund house’s website to invest in any of these index funds based on your risk profile and goals.
But before investing, remember, the volatility in these index funds cannot be ruled out, however, any such volatility in NAV will be in line with the market i.e. the index it tracks and hence the potential of returns will also depend on the index or the sector it tracks.
Also, index funds have something called tracking error that arises because the fund house charges management fees, marketing expenses and transaction costs (impact cost and brokerage) to its unitholders. Choose index funds that have low tracking error.
So, if you want to build a mutual fund portfolio for long term goals, you may diversify across such index funds tracking different indices and over the long term you may expect steady returns with lower volatility.