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The key to building a well-versed investment portfolio is diversification. The best way to diversify your investment portfolio is by adding different asset classes such as equity, real estate, debt, gold, index funds, etc. Very often rookie investors are stuck in dilemma and unable to decide how to start their investment journey that will help them to build a corpus for their future.
Index funds are one of the best investment vehicles available in the market that help the investor to easily multiply their capital without considerable degrees of risk involved in the process. While investing in equity the most suitable way to add diversification to the portfolio is by investing in shares and funds of organizations that belong to different sectors and capitalizations and this is where index funds come into the picture.
If you are looking forward to investing your hard-earned savings in index funds you’ve just landed at the right place. In this thread, we will decoding index funds and shedding light on the various nuances of the investment vehicle and its pros and cons to make sure that you make the most out of it.
An index fund commonly known as index tracker is a type of mutual fund or ETF (exchange-traded fund) which is designed and developed to follow a pre-decided set of rules and regulations so that the investor and fund can track a specific basket of investment. In other words, an index fund invests a pool of capital in stock market indices such as SENSEX, NIFTY, NSE, etc.
Index funds are always passively managed which basically means that the fund manager invests the pooled capital in the securities the same as the index and continues to do so in the same proportion throughout the course of the investment. Index funds usually yield returns comparable to the index that they track.
Equity index funds which are the most common type of funds chosen by investors all across the globe include a plethora of stocks with similar characteristics such as the size, rate of profit, value, and the geographic location of the company. One of the major advantages of index funds that makes it quite popular amongst investors is that they require very little time for management and analysis in comparison to other similar sorts of investment vehicles.
The functioning of index funds is quite similar to that of any other equity fund. In order to understand how do index funds work in real-time let us consider an exemplary situation. Let’s assume that Saad has invested in an Index that is tracking the NIFTY index. Now, as per the rules and guidelines, this fund will have 50 stocks present in the portfolio in a similar fashion.
Typically, an index fund can include equity and equity-based securities in the portfolio along with bonds which is another reason behind the popularity of index funds amongst investors. Fund managers managing the index funds ensure that one invests in all the securities that are tracked by the index.
An actively controlled and managed mutual fund attempts to outdo its fundamental benchmark, contrary to this, and index because of the passive management attempts to match the returns offered by fundamental index.
To make sure that you invest your funds at the right place, we’ve come up with the list of top 5 index funds in Dubai-
There are three major benefits of investing in index funds, they are as follows-
The first and foremost benefit of investing in Index funds is diversification which reduces the degree of risks associated with the investment. By diversifying an investment one can reduce the chances of losing their invested capital.
One of the best things about index funds is their low-cost requirement to begin investing. The low cost of index funds is mainly due to the fact that they are managed passively. Index funds have lower turnover in comparison to actively managed mutual funds which contributes and makes them a low-cost investment option for all classes of investors.
According to the majority of financial advisors and investment experts index funds have low investment cost and high rates of return which makes them suitable for investors that are planning to keep the investment cost low and returns high.
Investors willing to invest in index funds can purchase them via specialized brokerage firms or a mutual fund company that deals in the category. Some of the index funds require a minimum investment followed by a recurring investment. If you are planning to begin your investment journey it is recommended that you should begin with an investment company that does not require an account minimum.
While investing in Index funds one should analyze the performance of the fund in the past as it will help the investor to predict the performance in the future. Try and choose index funds that have a consistent track record of performance. Another important point to be kept in consideration while investing in index funds is the expense ratio. Investors should structurally analyze how much does the fund costs them and how much will they earn via returns on the fund.
Just like every other investment vehicle index fund have some downsides associated with them, they are as follows-
The first and foremost disadvantage of index funds is their low flexibility in comparison to other similar investment vehicles. The primary reason behind their low flexibility is that index fund managers have to follow the mandatory policies. The investment decisions made on index funds should be made under the constraints of matching the returns.
When compared to other investment vehicles and funds, index funds do not have the potential to outpace the market scenario the way managed funds can do. The gains in case of index funds are moderate which is one of the major disadvantages associated with them.
In a Nutshell
As mentioned earlier since index funds track market index are managed passively, they are less volatile in comparison to other equity funds. Therefore, the degree of risk associated with them is low and the returns are considerable. If you are looking forward to investing your money in index funds it is recommended that you compare different funds and then choose the right fund that will help you to grow your hard-savings exponentially.