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Index funds have become increasingly popular in recent years as a form of investment due to their many advantages over active mutual funds. Dozens of index funds have launched in India over the last few years, and more are expected.
Here’s a more in-depth look at why index funds are considered to be a better choice for many investors:
They Cost Less
One of the biggest advantages of index funds is that they have lower management fees than active mutual funds. These fees, also known as expense ratios, are the fees the fund company charges to manage the fund’s investments. Because index funds simply track a market index, such as the Nifty50, they have lower overhead costs, which can result in significantly lower expense ratios. For example, the average expense ratio for an index fund is around 0.05%. In comparison, the average expense ratio for an actively managed mutual fund is around 1%. Over time, these lower fees can add up to a significant difference in returns for investors.
They Have Been Performing Better
Another advantage of index funds is that they often perform better than active mutual funds, despite their lower fees. This is because active mutual funds often underperform the market indexes that they attempt to beat. This is because most fund managers cannot consistently outperform the market, and the costs of trying to do so, such as research and trading, can erode returns. On the other hand, index funds simply track the performance of a specific index, so they tend to perform similarly to the overall market. In fact, research has shown that over the long term, the majority of active mutual funds underperform their benchmark indexes.
Built-In Index-based Diversification
Index funds can provide a diversified portfolio, as they tend to hold many stocks across different sectors and industries. This diversification can help to reduce risk, as the performance of one stock is less likely to have a major impact on the overall portfolio. In essence, when you buy an index fund, you are buying an entire subset of the market comprised of the best companies. This is often better for a novice investor who may otherwise take exposure in a smaller number of individual stocks and thus have higher concentration risks in their portfolio. In this regard, index funds are not very different from active funds.
Simplicity
Index funds are a simple form of investment, as they simply track a specific market index. There is no need for investors to constantly monitor the fund’s investments or make decisions about buying or selling individual stocks. Additionally, index funds can be purchased through a brokerage account or directly from a mutual fund house. It makes them easily accessible to many investors.
Consistency
Index funds have a consistent investment strategy, as they simply track a specific market index. This consistency can help reduce short-term market volatility’s impact on the fund’s returns. In contrast, active mutual funds may make significant changes to their investments, which can result in more volatility in returns.
Overall, index funds are a simple, low-cost, and effective way to invest in the stock market and achieve long-term financial goals. While active mutual funds may be a good choice for some investors, index funds are better for many investors due to their lower costs, better performance, tax efficiency, diversification, simplicity, and consistency.
Additionally, index funds are a great choice for beginner investors or for investors who prefer a hands-off approach to investing.
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