For example, let us assume that a sample index consists of three Stocks, Stock A, Stock B and Stock C in the proportion of 45%, 35% and 20%. An index fund with a corups of say Rs 100,000 (RS 1 lacs) will invest Rs 45,000 in StockA, Rs 35,000 in StockB and Rs 20,000 in StockC.
Here is how Wikipedia defines Indexing.
“Indexing is traditionally known as the practice of owning a representative collection of securities, in the same ratios as the target index. Modification of security holdings happens only when companies periodically enter or leave the target index.”
An Index Fund is an example of Passive Investing.
Key Features of an Index Fund
- An Index Fund aims to deliver returns that are similar to the total returns of common stocks as represented by the index tracked – BSE Sensex or NSE NIFTY.
- It is suitable for new investors or those who want an exposure to equity as an asset class without the complexities of choosing specific stocks or high performing mutual funds.
- When one has a medium to long term invest horizon, an index fund systematic investment plan is a better investment option because of higher potential for capital appreciation and building wealth.
Traditional Benefits of Index Fund
An Index Fund is a Simple Product.
A no-brainer really. It replicates the “market” in a sense and tracks market movements. By market I mean BSE Sensex or NSE NIFTY or some other representative index.
When markets are on a bull run, you make almost similar returns. It will be lower than markets because of fund management fees. When markets go down, you lose slightly more than the market.
The formula for an index fund returns is as below.
Index Fund return = Market Return – Fund Management Fee
Illustration of Index Fund Returns
- For example, let us suppose that you invested Rs 10,000 in a NSE NIFTY index fund when BSE Sensex was 24,000. After 12 months, BSE Sensex is at 27,600 after increasing by 15%.
- Your Rs 10,000 investment would be worth Rs 11,400 for a 14% gain, assuming a 1% fund management fee.
- Using the same example as above, if Sensex went down by 10% to 21,600, your investment will actually go down by 11% to Rs 8,900, assuming a 1% fund management fee.
An index fund has lower costs than an active fund.
Since an index fund merely replicates the market index and pretty much works on auto-pilot mode, no highly paid analysts or fund manager are needed. The fund management costs are therefore lower compared to active funds.
If the fund management fee for a typical active fund is 2.5%, it will be around 1% for an index fund.
Typical fund management costs for index funds in US are around 0.2% whereas those in emerging economies like India re around 1%.
List of Index Funds in India tracking the NSE NIFTY
- Principal Index Fund
- UTI Nifty Index Fund
- Franklin India Index Fund
- SBI Nifty Index Fund
- ICICI Prudential Index Fund
- HDFC Index Fund – Nifty Plan
- Birla Sun Life Index Fund
- LIC NOMURA MF Index Fund – Nifty Plan
- Tata Index Fund-Nifty Plan
- UTI- Rajiv Gandhi Equity Saving Scheme
- IDFC Nifty Fund
- Taurus Nifty Index Fund
- IDBI Nifty Index Fund
- Reliance Index Fund- Nifty Plan
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A Few Last Words
Before making any investment decision, please contact your financial adviser. I have provided this article for educational purpose only.
I hope you found this article on Index Fund useful. If you have something to add please leave a comment in the post. Please feel free to contact me.