When somebody hears 'index tracking funds', the first thing to come to mind is usually ETF. But, little does everyone know that it's also possible to trade in mutual funds of a category that tracks an index's performance. These funds are termed index mutual funds.
What exactly are index mutual funds?
Index funds are a type of fund similar to index-tracking ETFs, but they can't be traded intraday. Unlike most mutual funds, index funds are passive. In other words, the fund manager builds a fund by holding the same stocks in the same proportions as the chosen index rather than selecting individual stocks.It's important to note that not all share market trading platforms may offer index mutual funds. For instance, while a holistic trading app like mStock would likely list index funds like the SBI Nifty Index Fund, other platforms may limit their offerings to just actively managed mutual funds.
Why are index mutual funds better than other mutual funds?
Has Lower Expense Ratio:
Index funds do not incur the same research costs and advisory fees associated with actively managed funds that employ portfolio managers. This makes it possible for investors to invest in these funds at zero brokerage fees alongside low annual expense ratios. More of an investor's money goes directly into the fund's holdings rather than paying for fund management.
Demands Little Financial Knowledge:
Their passive approach to tracking a particular market index eliminates the need for researching and selecting individual stocks. This is mainly because the funds' strategies are very straightforward—if the tracked index moves positively, the fund will be profitable. This attribute makes index funds perfect for those who have just opened a brokerage account and have yet to make their first investment through an app like mStock.
Provides Sufficient Diversification:
Investors can gain diversified exposure to an entire basket of securities through a single fund. This broad diversification across dozens of holdings helps mitigate company-specific risks. Thus, index funds are also good for experienced investors who want to balance their portfolios and work on long-term wealth management.
Some considerations of index mutual funds:
While index funds provide an opportunity to draw returns that reflect the performance of an index, they may bar investors from other profitable short-term funds. For instance, if a healthcare company's stock prices are steeply rising, but the company's stocks are not listed in any index, the investor can't include securities from that company in an index fund. Consequently, portfolio turnover may be lower than actively managed funds. Moreover, every fund provider has its own criteria for adding securities to index funds. That's why many websites mention a percentage to denote how many stocks of an index have been included in the fund. The exclusion of certain stocks can sometimes lead to wayward investment trajectories.Therefore, as a safe practice, investors should not limit themselves to index funds if their goal is to earn high returns quickly. Rather, they should explore other types of funds available on mStock and similar platforms.
The Bottom Line:
Index mutual funds are good for both novice and experienced investors for different reasons. However, they shouldn't be held as the sole investment if a trader wants to profit from sectoral stock price movements. Even though index funds don't necessitate advanced trading knowledge, investors should get accustomed to terminologies associated with index funds when they open demat account. This would ensure a smooth investment experience.
