What are Index Funds? Are Index Funds Returns High?

The primary element of an excellent investment portfolio is diversification. If you are new to the world of investment, try to spread your funds across different asset classes to minimise risk. A common mistake made by new investors is that they strive to outperform the market, which isn’t easy or realistic. Instead, try to stay in line with the curve. And to achieve this, you should know about index funds.

Understanding index funds

An index fund is essentially a mutual fund designed to mimic the portfolio of a financial market index. They are popular with investors who intend to replicate the performance of their underlying index. You can invest in a popular index like Sensex, Nifty, Nifty Next 50, Nifty 100, etc. But you must be sure that the scheme has matched the index consistently over a long period.

Essentially, index funds are a passive investment where the fund manager copies the index and tries to maintain the portfolio in sync with the index. In addition, index funds provide you with broad market exposure, low portfolio turnover and low operating expenses. Hence, they are quickly becoming popular among investors.

Additional Read: How to Choose Mutual Funds?

Should you invest in index funds?

Now that you have a brief idea about index funds, you might be asking yourself whether you should invest in index funds or not. Another question that must have occurred to you is whether the returns offered by index funds are high. Since index funds track a market index, they offer returns similar to those offered by the index.

Therefore, investors who want predictable returns and are in search of equity markets without taking a lot of risks prefer index mutual funds. Legendary American investor Warren Buffet has said that index funds are a haven for savings in your old age. This is because these funds don’t require extensive tracking, and you get the returns matching the upside of the index.

If you do plan of investing in index funds, consider the following factors carefully:

• Risk tolerance: Although index funds are less prone to equity-related risks and volatility, you must be aware of your risk tolerance nonetheless. This is because index funds can lose their value during a market slump.

• Financial goals: Is your goal to retire early or pursue your passion? Before investing your wealth in any instrument, have a clear picture of your goals. Knowing your aspirations will help you determine whether the investment is performing as expected or not.

• Investment horizon: Index funds are beneficial for investors with a long-term investment horizon. So, you must be patient enough to stick around and get the full potential of the fund.

• Cost of investment: Index funds have a low expense ratio as compared to other actively managed funds. This is because they don’t require the extra costs of fund management.

Thus, they are capable of generating high returns on investment.

Additional Read: How Mutual Funds are Taxed

Parting thoughts

Unlike actively managed funds, index funds don’t aim to beat the benchmark. However, they perform well over the long term and are less volatile.

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