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Wednesday, 21 July 2021

Standard - 3 Home Learning Video-2021-22

Standard - 3 Home Learning Video-2021-22


Standard - 3 Home Learning Video-2021-22.Diversification is a key element of a good investment portfolio. Investors try to spread their funds across various asset classes like equity, debt, real estate, gold, etc. Even within each asset class, they try to further diversify to minimize risks. 


In equity investing, a known method of reducing risks is diversifying your equity portfolio by investing in shares of companies from different sectors and of market capitalizations. This is where the Index Funds step in. Here, we will explore Index Funds and talk about the different types of index funds in India along with their benefits and a lot more.


As the name suggests, an Index Mutual Fund invests in stocks that imitate a stock market index like the NSE Nifty, BSE Sensex, etc. These are passively managed funds which means that the fund manager invests in the same securities as present in the underlying index in the same proportion and doesn’t change the portfolio composition. These funds endeavor to offer returns comparable to the index that they track.


Since Index Funds track a market index, the returns are approximately similar to those offered by the index. Hence, investors who prefer predictable returns and want to invest in the equity markets without taking a lot of risks prefer these funds. In an actively managed fund, the fund manager changes the composition of the portfolio based on his assessment of the possible performance of the underlying securities. This adds an element of risk to the portfolio. 


Since index funds are passively managed, such risks do not arise. However, the returns will not be far greater than those offered by the index. For investors seeking higher returns, actively managed equity funds are a better option.


Since index funds track a market index and are passively managed, they are less volatile than the actively managed equity funds. Hence, the risks are lower. During a market rally, index funds returns are good usually. However, it is usually recommended to switch your investments to actively managed equity funds during a market slump. 


Ideally, you should have a healthy mix of index funds and actively managed funds in your equity portfolio. Further, since the index funds endeavor to replicate the performance of the index, returns are similar to those of the index. However, one component that needs your attention is Tracking Error. Therefore, before investing in an index fund, you must look for one with the lowest tracking error.


Expense Ratio is a small percentage of the total assets of the fund charged by the fund house towards fund management services. One of the biggest USP of an index fund is its low expense ratio. Since the fund is passively managed, there is no need to create an investment strategy or research and find stocks for investing. This brings the fund management costs down leading to a lower expense ratio.


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