Index funds are a type of mutual fund that is a low-cost, high-diversification investment solution. Unlike most mutual funds, index funds are passively managed.
They are designed in a way that they track a specific market index such as the BSE Sensex or Nifty 50. Index funds aim to closely track and replicate the performance of the benchmark index that they are tracking.
Let’s quickly go over the features of index funds:
- Index mutual funds do not try to outperform their benchmark index but rather they simply aim to mimic its returns.
- The involvement of the fund manager is minimal and there is no stock picking that happens since the underlying securities of the index fund are the same as that of its benchmark index.
- Since index funds are passively managed, they come with a lower expense ratio and are more cost-effective for investors.
- Index funds try to mimic the stock market as a whole, or the broader market, instead of betting on any one investment and hence in the long run tend to perform well.
- They may have a tracking error which means that the index fund may not always closely follow its benchmark and hence you should look at investing in index funds with a minimal tracking error.
While index funds are a great way to invest in the stock market, there are some other ways also that you can consider. It’s always helpful to know all your options.
Ways to invest in the stock market
Invest in stocks directly
The first way to invest in stocks is by opening a brokerage account online and starting to invest in shares of individual companies that you have identified as good investments. You have the most control in this option of investing in the stock market as you get to make all the decisions about what to buy when to buy when to sell, etc. For this, having a basic knowledge of how the markets work is crucial.
This option also requires you to closely track the market trends and conditions so that you make the right calls at the right time.
Mutual funds
If you are just beginning to invest or want to play a passive role, then mutual funds are a great way to invest in the stock market. There are several types of equity mutual funds that invest primarily in equity and equity-related instruments and while they each have a different objective, the primary objective generally is wealth creation in the long term. There is also the benefit of diversification because unlike investing in individual stocks when you invest in a mutual fund, you invest in stocks of multiple companies so the risk of anyone’s stock not performing well is hedged. There are also fund managers who make important investment decisions, so your money is being handled by professionals. As discussed above, index funds are a great choice to consider as a beginner.
Exchange-traded funds
ETFs are an investment product that brings to you the benefits of both stocks and mutual funds. An ETF is a basket of securities that tracks an index, commodity, or other assets to mimic its performance. ETFs have shares that are traded in the stock market just like regular shares are.
The unique part about ETFs is that they allow you to invest in the broader market instead of just one company or sector and they have a low expense ratio as they follow the passive investment management strategy.
The bottom line
All ways of investing in the stock market, including index funds, can be beneficial to you as an investor. Ideally, you shouldn’t rely solely on one method of investing in stocks and should have a mix of ETFs, mutual funds, and individual stocks. For the right asset allocation, you will have to draw out an investing strategy in which you should look at your goals, investment horizon, and risk appetite.
