You may have heard about index funds from the likes of the Barefoot Investor or even the esteemed Warren Buffet – there’s a good reason they’re so well-regarded.
An index fund is typically a low-cost, low-risk investment portfolio of shares that tracks a financial market. The index fund approach is to simply mimic the stock market rather than try to outperform it. Because it’s a lot less work for fund managers, the fees are usually much lower than other kinds of investment funds.
But how do you invest in them and what makes them so popular? This guide cuts through the financial jargon to cover everything you need to know about index funds in India and why they’re creating so much buzz.
How to start investing
If you already understand what index funds are and want to start investing, you can do so through a fund manager, a full service broker or an online share trading platform. One of the easiest and cheapest ways to access index funds is via exchange traded funds (ETFs) which are traded on Indian stock exchanges, like the National Stock Exchange of India (NSE) and the BSE (formerly known as the Bombay Stock Exchange).
Before you do so, you should know that not all ETFs are index funds and some funds are riskier than others – you can read more about this below.
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What are index funds?
Like other kinds of investment funds, an index fund is a portfolio of stocks and sometimes other assets such as gold or cash. The idea of an investment fund is that instead of buying shares in one company or one asset, you can invest in a bundle of them.
To deliver profits for their clients, fund managers usually buy and sell assets within the fund by trying to predict market movements. This difficult feat is known as “active” management. On the other hand, an index fund is a pool of company stocks that mimics a financial index, requiring little intervention from its fund managers.
The index fund approach can be used by all kinds of investment funds, including exchange traded funds (ETFs), managed funds and even super funds.
In India, you’ll often hear people refer to index funds as ETFs or vice versa. This is somewhat misleading because not all ETFs are index funds (although most in India are) and not all index funds are ETFs!
What is a stock market index?
To really understand an index fund, it’s important to know what an index is. A market index is a collection of stocks that are listed on a stock exchange. India’s most well-known index is the Nifty 50, which consists of the largest 50 companies on the NSE. The Wall Street alternative is the S&P 500 index, which includes the top 500 listed companies in the US.
You’ll notice these indices are often cited in the media because investors use them to track the overall performance of a market. They rise and fall depending on a range of economic indicators and company news. For example, when an economy is healthy, its stock market indices tend to rise because investors feel more confident buying stocks. If trade tensions increase between countries, stock market indices usually fall as investors become nervous.
How do index funds work?
Index funds hold a selection of stocks that make up an index.
If a company leaves an index, the fund manager simply sells its shares and replaces it with new stocks. For this reason, index funds are considered a comparatively safe alternative to directly buying shares in a company. Because these kinds of funds require minimal management, it’s known as “passive” investing.
It’s important to note that while index funds are sometimes called ‘mutual funds’ overseas, within India, the term “index fund” more often refers to exchange traded funds (ETFs).
What is an ETF?
An ETF is a basket of securities that’s listed on a stock market, such as the NSE or the BSE. In India, ETFs are typically “passive” investments that track an asset or index, but this isn’t always the case.
Confused about the terminology? You’re not alone. These terms are changing all the time and vary across different borders.
Despite the popularity of traditional managed (sometimes called mutual) index funds in the US and other countries, there are few such options available in India. Instead, many Indian investors use ETFs to track indices as they work in much the same way but are easier to access and have a lower minimum cost requirement.
Index funds vs ETFs
Most ETFs are similar to traditional (unlisted) index funds in that they are low-cost and track a major underlying index, though there are a few key differences:
- ETFs are listed on a stock exchange. The main difference is that ETFs are traded like shares on the stock exchange while index funds are unlisted managed funds.
- They’re priced differently. The price that you pay for an ETF is its market value depending on its performance on the stock market. The price that you might buy or sell into an index fund is the net asset value of its underlying securities.
- Buying and selling. ETFs can be bought or sold at any time during a trading day, whereas managed funds are only priced at the end of the day.
- ETFs have lower minimum investment. Index funds typically require an initial minimum investment of ₹5,000. On the other hand, there is no minimum investment amount for ETFs traded on Indian stock exchanges. You can buy as little as one share in an ETF for less ₹100.
- Index funds don’t charge a transaction fee. There’s almost always a brokerage fee involved when buying or selling an ETF, but index funds tend to skip this cost. This means that a managed index fund can be a good option for investors looking to frequently add small amounts to their fund over time.
- ETFs have lower fees. On the other hand, taxation and management fees tend to be lower for ETFs than traditional index funds.
Why invest in an index fund?
Simply put, index funds have been proven to outperform many other kinds of investments.
In 2007, one of the world’s most successful investors, Warren Buffet, made a US$1 million bet that a bundle of active managed funds would be worse off than the S&P 500 over 10 years. He argued that if a fund simply mimicked a major index, it would deliver better returns than a fund actively managed by professionals. A decade later, Buffet won that bet.
The point is that although major indices fluctuate from year to year, they usually rise over a long period of time. For example, the Nifty 50 index fell by more than 50% during the 2008 global financial crisis. But even if you had invested in the index fund just prior to that, you’d still be in a better financial position today than if you’d not invested at all.
What are the benefits of investing in an index fund?
- Index funds cost less. Passive funds require less legwork, so they typically charge lower fees than actively managed funds. In managed funds, high fees can easily eat into any returns gained by the broker.
- They can achieve higher returns. Indices have been proven to frequently beat the average returns achieved by fund managers over many years. Coupled with lower fees they make good investing sense.
- Ease of trade. Many ETFs listed on the NSE and the BSE are index funds, which are easily accessible on broking platforms.
- It can diversify your portfolio. Investing in an index fund offers access to a range of companies from various sectors.
- They’re relatively safe. Index funds are considered a safer alternative to direct stock market investing because indices are generally less volatile than individual stocks.
Of course, no investment is ever 100% “safe” and you should always seek professional advice before making any investment decision. Here are some of the risks that investors need to be aware of:
What are the risks of index funds?
- You could lose your money. Like any investment, you take the bad with the good. When an index does well, your investment delivers profitable returns, but when an index drops, so does your investment.
- It’s not a short-term plan. Passive funds perform best over many years. If you invest in an index fund but find you need the money six months later, there’s a good chance you’ll have less than you started with.
- Not all assets are safe. Although many index funds track relatively safe major indices, technically any pool of assets can be bundled into a fund. Some index funds track volatile global markets, such as the oil sector, while others bundle in riskier investment assets. Always do your homework.
- Not all ETFs are index funds. ETFs come in all shapes and sizes and not all are passively managed. Some are highly complex and risky.
Popular index funds and ETFs available in India
There are more than 100 index funds to choose from in India and most of these aren’t labelled “index funds” so it can be tricky to source a full list. Below are are some of the most well-known index funds available in India.
|Nippon India ETF Nifty BeES||Nifty 50||ETF|
|SBI ETF Nifty Bank||Nifty Bank||ETF|
|Motilal Oswal Midcap 100||Nifty Midcap 100||ETF|
|HDFC Sensex ETF||BSE Sensex||ETF|
|Motilal Oswal NASDAQ 100 ETF||Nasdaq-100||ETF|
|UTI Nifty Index Fund||Nifty 50||Unlisted|
|ICICI Prudential Nifty Next 50 Index Fund||Nifty Next 50||Unlisted|
|Nippon India Index Fund – Sensex Plan||BSE Sensex||Unlisted|
Steps to invest an index fund
Most major fund managers offer access to a limited pool of index funds, though ETFs are the more readily accessible option within India.
Traditional index funds can be purchased directly through their associated fund providers, such as ICICI Prudential Asset Management Company or SBI Funds Management. ETFs can be purchased with any regular stockbroking account.
Whether you want to invest in an ETF or an unlisted index fund, these are the steps you need to follow:
1. Consider your strategy
Ask yourself what you want to achieve through this investment. Consider your time frame and how much risk you’re willing to take on. Will you need to withdraw the funds in a year’s time or can they sit for 10 years?
2. Assess your options
Compare funds online to find a product that matches your goals. Consider the risks, the fund’s performance, the brokerage fees and other transaction costs.
Key things to take into account when deciding on an index fund:
- Brokerage fees
- Transaction fees
- The fund’s performance over the last 3, 5 and 10 years
- Are the fund’s assets safe or does the fund contain some volatility?
- The minimum investment amount and how often you plan to transact with the fund
3. Sign up through a fund manager or online broker
Once you’ve found the right product, you’ll need to work out the best way to access it.
Index funds can be accessed through their fund providers such as SBI Funds Management or ICICI Prudential Asset Management Company.
- When applying directly to a fund manager, you’ll need to fill out an application form, provide proof of address, ID and your Permanent Account Number (PAN). This will need to be posted or emailed back with a cheque or proof of transaction.
- Financial planners can also apply for an index fund on your behalf.
ETFs are accessible on most online trading platforms and can be purchased just like any other stock. You’ll need to sign up for an online share trading platform. To do this, you’ll need to:
- Provide personal details and proof of ID
- Transfer money into your trading account
- Log in to your account
- Search for the ETF you want and place a buy order
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