An important factor to consider when investing in mutual funds is diversification. Diversification in mutual funds helps to lower risk due to market volatility, which is especially high in equity mutual funds. Hence, as a means to reduce risk, investors seek to diversify their equity mutual fund portfolio across stocks of different companies that differ in terms of sectors and market capitalizations. One effective medium to reduce the risk of equity funds is to invest in index mutual funds. Index mutual funds are passive funds that imitate popular market indices, ensuring standard returns and low risk.

Here is everything you should know about index mutual funds:

What are index mutual funds?

Index funds are mutual funds that mimic a popular market index, such as NSE (National Stock Exchange) Nifty, BSE (Bombay Stock Exchange) Sensex, etc., and invest in the same stocks as the index. The objective is to ensure the mutual fund portfolio performs in tandem with the particular benchmark index it follows.

Index funds are managed passively, implying that the fund manager creates a portfolio with the identical securities and proportion as the standard index with a goal to generate returns nearly equivalent to the index that they track.

How do index mutual funds work?

Index mutual funds track a particular index, such as NSE Nifty Index, and have the same investment portfolio in similar proportions. When you invest in an index mutual fund, the fund manager uses your money to invest in all the companies that constitute the particular index. This ensures your portfolio is more diverse than if you would create an individual equity mutual fund portfolio.

Index funds follow a specific index like BSE Sensex. Hence, they fall under the passive fund management category. Unlike actively managed mutual funds, there is no independent research analyst team to identify opportunistic investments and choose stocks. This means that the fund manager buys and sells stocks as per the underlying benchmark.

What are the advantages of index mutual funds?

Some advantages of investing in index funds are:

  • Low fees because of passive management
  • No bias in investment choices because these funds mimic a particular index
  • Optimum diversification due to a broad market exposure
  • Index funds are easier to manage, and the fund manager only periodically rebalances the portfolio.
  • Index funds generate attractive returns but are lower than equity mutual funds. Hence, the tax bill on index mutual funds tends to be lower.

Who should invest in index funds?

You should invest in mutual funds as per your risk tolerance, investment horizon, and financial objective. If you are a risk-averse investor with a medium-to-long-term horizon and aim to generate decent returns, consider investing in index mutual funds.

ConclusionHowever, before investing in these mutual funds, be careful of the underlying index and cost of investment. Use the Tata Capital Moneyfy app to analyze different index mutual fund options and choose one that best aligns with your requirements. You can also use the digitally-smart Moneyfy app to monitor and manage your mutual fund investments.