Why Index Funds are the best choice for New Investors?

So you want to start investing? Congratulations on starting your journey of wealth creation!

But now that you’re in, you start to realize that finding a good stock or a mutual fund to invest into is difficult. There are currently over 7000 listed companies in BSE and around 2500 mutual funds in India (data of December 2020). This makes it very difficult for beginners to find a good company or a good fund to start investing their hard earned money.

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There is a type of fund which generally gets ignored by most retail investors in India which might be the best fund for them – Index Funds. Index Funds are a type of mutual funds or ETF (Exchange Traded Fund) which track a particular index such a Nifty, Sensex, Bank Nifty, etc. The goal of an index fund is simple – buy all the shares in the exact same proportion as the index which it is tracking. Here are the top 10 companies in the Nifty index as per the NSE website (to find the current Nifty weightage from the official NSE website, click here) for the month of November, 2021 –

An index fund tracking Nifty should divide the total investment amount into exact proportion as the company weightages. E.g. Index funds tracking Nifty should have 10.56% of their invested amount into Reliance Industries, 8.87% of their invested amount into HDFC Bank, 8.62% of their invested amount into Infosys and so on for the month of November, 2021. These companies and their weightages can change from time to time and so the index funds re-balance their portfolios to ensure proper tracking of the index.


Here are the reasons why Index Funds are the best for most beginners –

  • Automatic investment into leader companies

Most indexes such as Sensex, Nifty, Bank Nifty, etc. comprises of big companies which are leaders of their sector. The current top 10 companies of Nifty include companies such as TCS, Infosys, Reliance, Hindustan Unilever, HDFC Bank, etc. which are some of the biggest companies in India and are a leader of their sector. This ensures that investing in an index fund automatically means that you are investing into some of the biggest companies in India which have build decades of trust amongst investors. Most new investors fall into a trap of buying very small & unknown companies in the hopes of making big returns but eventually end up losing all of their money. Index funds prevent investing into smaller companies simply by it’s design! If you want to pick stocks yourself, visit this article for a step-by-step guide  – How to choose your first Stock?


  • Provides market returns

This might seem like a drawback of the Index Funds but in fact this is one of the biggest plus points. Index Funds do not have a fund manager who is buying and selling stocks based on his/her analysis. Index Funds is a no-brainer way of picking stocks – pick exactly what is in the index at the exact same proportion. There are no deviations involved when compared to the index returns except for a very minor percentage of tracking error (generally less than 1% for good index funds).

Result – If the Index goes up by 20%, so does the Index Fund. If the Index goes down by 20%, so does the Index Funds. Index funds by design provide the market returns which is great for passive investors who are just interested in investing in the stock market and are not very familiar with picking stocks. 


  • Low Volatility

Index tends to have a much lower volatility compared to individual stocks because the index is composed of multiple companies which is great for beginners who are unable to handle volatility. On a trading day it is possible that a particular company may experience high volatility but because that company is only a small percentage of the total index, the volatility of the index will be low. 

E.g. if you hold shares of ICICI Bank you will be experiencing the volatility which that share undergoes. However, if you hold the entire Bank Nifty Index Fund the volatility experienced will be much lower. Index is comprised of multiple companies and therefore is less susceptible to experience wild upswings or downswings.


  • Protects investors from holding onto failing companies

Every now and then some top companies will prove to be old horses who are unable to perform well and need to be replaced with newer, better companies. All indexes have a rebalancing which replaces underperforming companies with new upcoming companies. One of the latest examples of a rebalancing was to replace Yes Bank which fell spectacularly from being one of the fastest growing bank to a scam ridden company within a span of 1 year and caused extreme erosion of investor’s capital. Yes Bank was replaced by Shree Cements in the Nifty index. Such rebalances are done regularly in Index which ensures that passive investors do not need to worry about failing companies. These companies will be automatically replaced in the Index and since the Index fund directly follows the Index, this will ensure that investors will not be holding onto failing companies.


  • Low commissions

This is one of the biggest advantages of the Index Funds. Most actively managed mutual funds have a high commission fee (called exit load) which the investor has to pay for the services which the fund manager is providing to them. However since there is no such thing as picking stocks in an index fund, the fees are much lower compared to the Mutual Funds. This is crucial because just like your portfolio compounds over time, so do the fees. Some mutual funds might even underperform when compared to an index fund making this a double blow to your portfolio wealth. 


  • Cannot lose money over a long term horizon

Nifty Index was at 1100 points in 2001 which increased to 6000 points in 2011 and currently is trading at 17000 points in 2021. The clear take away is that investing in index funds is a profitable venture over the long term. Index tends to increase in value over time unlike individual companies which can go from hero to zero in a matter of a few years (or even months). Investing in an Index Fund which tracks the Indian stock market is basically like investing into the growth of India which is a very  safe bet to take. 


The growth of India will become the growth of your portfolio!


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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.


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Namit Pandey

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