Managing a portfolio is a tough decision but a very important one if someone wants to reduce its risk. Index funds are those funds that invest in a broader market index like Sensex or Nifty. Index funds replicate the risk and return of the market.
These funds are those which are not actively but passively managed by the portfolio managers. If an investor invests in an index fund then the maximum return he can receive is the market return. More often not, this return is lesser than the market return because of the additional cost involved in investing.
How do Index Funds Work?
An index fund tracks a benchmark like the Nifty 50. This funds will have the same 50 stocks and in exact proportions that are present in Nifty 50. A portfolio manager does not have to do anything but follow the changes in the index. Thus, the work which portfolio managers have to do is very limited. This is why index funds come under passive fund management.
Key points for an investor
- Index funds are a very good option if an investor wants to invest in a bullish market.
- Investing in index funds incurs less cost when compared to the active funds. The latter concerns the huge involvement of the portfolio manager to take decisions. Thus, higher fees are levied on active funds.
- An index fund does not aim to beat the benchmark. Its objective is to replicate the market indices.
- Index funds are subject to dividend distribution tax and capital gains tax.