Can Index Funds Be Your Best Bet?

Buying stocks in India or the US can be a challenging task even for seasoned investors. There are more or less 5,000 stocks to pick from and each stock has its own pros and cons.

Even if you do manage to pick the right stocks, you’ll need to constantly monitor them. After all, market conditions may change at any time. Index mutual funds can provide a solid solution to these problems. 

What Are Index Funds?

Index funds are mutual funds or ETFs that invest in all the stocks from an index. They’re generally named after the index they invest in. For example, a Nifty 50 Index Fund will invest in all the stocks from the Nifty 50 index. 

Index funds consist of the same stocks in approximately the same proportion as the index they mirror. That’s why investing in index funds is popularly known as “buying the market”. 

This phrase isn’t entirely true. But it does convey a meaningful message. Instead of buying a stock or two, buy an entire index of diverse stocks to increase your odds of earning lucrative returns.

Diversification isn’t the only benefit of investing in index funds, as you’ll see in the upcoming sections. But it is arguably a top reason for everyday investors to explore index mutual funds. 

How Do Index Funds Function?

So far, we’ve discussed the fundamentals of index funds that include:

• Type: Fall under the category of mutual funds
• Portfolio: Invest in all the stocks in a similar proportion to the index they track 
• Name: Same as the index they track

On to the specifics. Most mutual funds are actively managed. A fund manager and their team handles the day-to-day operations of the mutual fund in order to keep up with the market. 

Index funds aren’t actively managed. A fund house or manager will set up a portfolio and then periodically revisit it to make adjustments. Index funds are thus passively managed. 

This comes with an advantage - low cost. The fund house or manager doesn’t have to buy and sell stocks daily or weekly. Thus, the amount of maintenance required in an index fund is low, as is the cost.  

That’s not all. The turnover ratio of an index fund is lower than other equity mutual funds. A turnover ratio is the number of times a fund’s portfolio has changed within a year.

Say for example a mutual fund has 500 stocks in its portfolio. If it replaces 50 of those stocks in a single year, then the turnover ratio will be 10%. The turnover ratio of an index fund ranges from 1% to 2%. 

Why Invest In Index funds?

By now, you would’ve realised that index funds carry a host of benefits. These benefits can be useful for busy professionals who don’t have the time to pore over charts and graphs. 

In fact, the benefits of investing in index funds have been acknowledged by billionaire investors. We’ll get to that towards the end of this section. 

Without further ado, here are the reasons why you should invest in index funds.

1. Low-Stress

Index funds take away the burden of research to a large extent. You won’t have to worry about picking individual stocks and the risks that come with them. 

Instead, you can benefit from the comfort of knowing that you’ve invested in an entire index of stocks. Furthermore, there’s the added advantage of professional management that comes with index funds.

2. High Diversification

An index fund isn’t a basket of stocks, it’s a hamper of diverse shares from various industries. Take for example an index fund that tracks the Nifty Next 50. It gives you access to stocks from sectors like:

• Pharmaceuticals & Drugs
• Cement
• Power Generation/Distribution
• Hospital & Healthcare Services
• Retail
• Finance - NBFC  

Some indices may have underperforming stocks or sectors. But that may be averaged out with the high performing ones in the index fund’s portfolio, which is spread across multiple stocks and sectors. 

3. Low-Cost

Index funds are passively managed, which means that there isn’t much day to day buying and selling of stocks involved. Passively managed funds carry a lower cost because of this. 

The same applies to index funds as well. Most index funds carry an expense ratio that’s typically lower than actively managed equity funds. The cost can be as low as 0.5% or 1.5% at the most. 

4. Lucrative Returns

Most top indices are known to grow linearly over a period of five years or decades. That’s why investing in an index fund that tracks the S&P 500 or Nifty may give you the chance to make lucrative returns.

Index funds have been known to generate solid returns on par with the market. The returns can range from 10-12% over a 5-year period. See how the Indian and US stock market has grown over the last 22 years.

5. Trusted By Billionaires 

The proponents of index funds include the likes of Warren Buffett (net worth: $129.7 billion). The Oracle of Omaha himself has been known to openly vouch for the benefits of investing in index funds.

In fact, Buffett has instructed his trustee to invest 90% of his cash in a very low-cost S&P 500 index fund. Buffett also mentioned that index funds could be a great way to make money for everyday investors. 

List Of Best Index Funds

Index funds can be a solution to the problem of time and effort required to pick individual stocks. That said, you still have to choose the right index fund to make money. 

Most AMCs in India offer an index fund in some form or the other, so the choice becomes relatively difficult. Cube bridges this gap by giving you access to the best index funds with the help of Wealth First.

Here are the best index funds currently being recommended on Cube.

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Frequently Asked Question around Index Funds

Q. Which Is The Best Index Fund?

An index fund that can help you achieve your financial goals is the best, at least based on general rules of investing. Along with your financial goals, the index fund should also be in line with your risk profile.

Based on these two factors, you could either invest in index funds from India or the relatively riskier index funds from the US. Here are the best index funds in India according to Cube's advisor Wealth First:

• Motilal Oswal Nasdaq 100 Fund of Fund
• Motilal Oswal S&P 500 Index Fund
• DSP Nifty Next 50 Index Fund

Q. Is An Index Fund Worth It?

Index funds are known to generate solid returns (10-12%) while being low cost and effective investment options. Moreover, index funds ensure that busy professionals don't have to examine several stocks. Instead, they can buy an entire index worth of stocks for diversification.

Does this mean index funds are worth it? Yes and no. Yes because index funds can generate returns on par with the market. No because the answer isn't so easy - you need to evaluate your risk profile and financial goals before investing in any index fund.

Q. Are Index Funds Better Than Stocks?

Stocks will always have the potential to beat the market and be multibaggers. Index funds are not known to have a similar potential. But the use case of index funds is entirely different from stocks. Index funds are suitable for busy professionals and those who are overwhelmed by stock research.

There are nearly 5000 stocks to be chosen from in India and the US. Index funds ensure that you don't need to evaluate every other stock and instead, you can buy an entire index for greater diversification.

Note: Facts & figures are true as of 29-03-2022. None of the information shared here is to be construed as investment advice. Exercise caution when investing in assets like stocks, mutual funds, alternative investments, and others.