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Could Index Funds be the answer to riding this market volatility

May 27, 2020
4mins | Views 8962

The Indian stock market has been going through pendulum upswings and downswings since several months now. From breaching an all-time high in January 20201 to crashing to an almost 3 year low2 just a few months later in March 2020, the market has seen considerable volatility.

Source:
1. https://www.businesstoday.in/markets/stocks/sensex-hits-all-time-high-nifty-at-12385-bharti-airtel-reliance-industries-hero-motocorp/story/393997.html
2. https://www.moneycontrol.com/news/business/markets/sensex-nifty-at-fresh-3-year-low-5-factors-could-be-weighing-on-market-5046081.html

Making investment choices especially for novice investors is tough in times of economic instability and market volatility. While a consistently falling and undervalued market may seem like a good time to invest in equity, it also makes picking the right stocks challenging. Several Asset Management Companies (AMCs) and fund houses offer a variety of index funds as a suitable investment avenue for such volatile times. So, are these index funds right for you as an investor? Let's delve into the details of index funds to get a better insight.

What is index fund?

To understand index based mutual funds schemes we should first know what a market index (indices) is. A market index is not a specific stock or investment form but a representation of a specified collection of stocks. These stocks can be grouped based on several parameters such as market capitalisation, sector etc. The prices and weightage of these individual stocks contained in the index are the basis for calculating the price of the index. Tracking an index can thus give you a snapshot view of the performance of the category of stocks it represents. The BSE SENSEX for example is a collection of 30 blue-chip companies listed on the Indian stock market.

An index fund is a mutual fund scheme whose investment objective and strategy is to track and mimic an underlying index. For example - an index fund whose base is the NIFTY 50 will invest its corpus in all the stocks comprised in the NIFTY 50 index in the same weightage as found in the index.

Why opt for index funds?

  • Broad market exposure with minimal investment
    An index fund can be a good way to invest across a wide spread of stocks even with a small amount of money. Index funds like most mutual fund schemes have low minimum investment requirement and thus offers you considerable diversification even with minimal funds.
  • Low cost
    As index funds mimic the underlying index, they do not require fund manager expertise and are thus passively managed funds. These funds therefore have a considerably lower expense ratio as compared to actively managed funds. This low cost can add to your investment value over the long run.
  • Elimination of human bias
    Being passively managed, index funds are not dependant on fund managers expertise. They are not subject to the fund managers judgement in times of volatility.
  • Variety of offerings
    AMCs today offer a variety of index funds that track different types of indices. From the BSE SENSEX to NIFTY 50 to a wide variety of sectoral indices, investors can choose their choice of index fund based on their profile.

The flipside of index funds

While index funds can be opted for by novice investors to invest in the market with minimal effort, their passive investment strategy may not be conducive to all types of investors.

Actively managed funds aim to generate higher than market returns giving you a potential edge in your portfolio. Index funds can probably miss out on sectoral or other growth opportunities that may present itself in the stock market as it is a restricted to a specific basket of stocks.

To sum up

The aim of investing in an index fund is to achieve a long-term reasonable return akin to the market indices. So, index funds can be one of the options to enter the market in volatile markets with minimal knowledge and effort. Index funds can also be opted for to bring balance and diversification to your investment portfolio.

Yet one should not undermine the importance of having a balance of index funds and other actively managed funds to give a balance of risk and reward to your portfolio.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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