Posted on 7/3/2023 6:30:00 PM

A variety of options are open to any retail investor who wishes to invest their income in mutual fund schemes today. One of the sub categories  of mutual fund is index mutual fund schemes. Like any other popular sub-category of mutual fund investments in India, index mutual fund schemes, too, have characteristic features and benefits; and there are certain factors that you must consider before investing in these schemes.

What are index mutual funds?

Index mutual fund schemes form a sub-category of mutual fund schemes in India. They are passively managed mutual fund schemes that track the underlying market index. Since index mutual fund schemes are managed passively, they have a lower ‘expense ratio’ – the fee charged by mutual fund companies to manage investors’ money and allocate the funds in various mutual fund schemes. To further exemplify, an index mutual fund scheme can track the popular BSE (Bombay Stock Exchange) and NSE (National Stock Exchange) indices with the aim of producing returns that mirror these indices’ offered returns subject to tracking error.

How can an investor benefit by investing in index mutual funds?

As we mentioned earlier, index mutual fund schemes usually have a lower expense ratio as compared to other mutual fund schemes since they are not actively managed mutual fund schemes. These schemes usually involve low risk and can be considered as a good option for first-time investors to start their investment journey. One of the key advantages of investing in index mutual fund schemes is that it is quite convenient for any investor to manage and oversee their investments. Also, retail investors find it very convenient to invest in these schemes since they do not require a demat account or a broking account to get started.

Things you must consider before investing in index mutual fund schemes

You shall find enlisted in this section a list of considerations that you must make before investing your money in an index mutual fund:

1. Be aware of the ‘tracking error’
There might, in some cases, be a slight deviation in the returns earned from an index mutual fund scheme when compared with the benchmark index that it tracks. This is called a ‘tracking error’.

2. Consider market fluctuations
You must bear in mind that the market is unpredictable. While you might have made more capital gains in a bull market (when the share prices are usually on a rise), you have equal, if not more, chances of running into losses in a bear market (when there’s a drop in the investment prices). You must, therefore, evaluate your risks properly before making an index mutual fund investment.

3. Consider the investment horizon
Just like sectoral schemes, the returns may vary based on the market’s cyclic movements. You must be willing to invest for the longer term if you wish to earn better returns through an index mutual fund investment.

4. Choose a lower expense ratio
It is true that index mutual fund schemes have a lower expense ratio. So, make sure to do your research to find the index mutual fund scheme of your choice with the lowest expense ratio.

Finally,  you can consider investing in an index mutual fund scheme if:

•  You wish to earn returns offered by benchmark indices such as Sensex or Nifty.

•  You wish to diversify your investment portfolio.

•  You wish to earn cost-effective and moderate returns through your mutual fund investments.

An index mutual fund investment can be a good investment option for an investor, irrespective of whether they are just starting out or have experience in investing. You must, however, consider all of the points that we have enlisted in this article before deciding whether to invest in index mutual fund schemes.

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

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