Equities are known to have the highest potential for growth among investment options. The growth of stock market indices, which track the performance of the stock market as a whole, underlines this fact. For instance, Nifty 50 is a benchmark stock market index representing the weighted average of 50 of the largest Indian companies listed on the National Stock Exchange (NSE). The Nifty has grown around 80% in the last five years, as of December 12, 2022.
Does this mean that if you had invested in the Nifty 50, you could have gained similar returns in five years? And how do you invest in a Nifty or Sensex index? Let us take a look.
Investing in indices
There are two main ways to invest in any index. First, you can invest in them directly. You can look at the composition of the index of your choice and create a portfolio similar to that. But this comes with one major problem – cost. You will have to buy each of the shares, which could be costly.
Further, you have no option to invest an amount that you like. This brings us to the second option – funds. Index funds are one such option.
What is an index fund?
A mutual fund that tracks a certain market index is called an “index fund.” A market index is a fictitious stock and security portfolio that reflects a certain market sector. For instance, Nifty 50 is a stock market index that tracks the performance of the top 50 companies on the NSE. A nifty index fund tracks the Nifty index as it is.
Index funds fall under the category of passive fund management since they mirror the performance of an underlying index by purchasing and selling stocks and other assets in accordance with that index’s rules. Apart from that, the fund’s success is not contingent on the stock picks of its investors.
Investing in index funds through SIPs
You can invest in the index as a lump sum and through systematic investment plans (SIPs). An SIP is an investment vehicle given by many mutual funds, enabling you to invest modest amounts monthly instead of large investments. The frequency of investing is commonly weekly, monthly or quarterly.
Investing in index funds through SIPs removes the need to time the market. This is due to an effect called the rupee cost averaging. The rupee cost averaging strategy is investing a certain amount of money at regular periods, regardless of whether the markets are rising or falling. That way, you may stock up while prices are low and reduce your holdings when they rise.
The magic of compounding as well complements SIP investments. Compounding ensures that your profits are reinvested into the corpus so that the compounded corpus will earn returns.
How to analyze index funds’ returns?
The best way to analyze index funds’ returns is by looking at the fund’s growth. Here, there could be smaller variations between the fund’s growth and the index’s growth. This is called a tracking error. This happens primarily due to the fund’s additional charges, including the expense ratio.
When it comes to SIP investments, what matters the most is choosing the right fund. Index funds are not limited to Nifty or Sensex alone. There are many sector-wise indices for you to choose from as well.