Guide 101 : Index Fund Investing

With great return comes great risk. But did you know about a special type of Mutual Fund which is good on returns but very low on risk? Let’s find out!

Before Index Investing, Let me explain what Mutual Funds really are. Let’s say you have saved some money for investment purpose and You’ve heard stock market can bring in fortunes when money is invested in ‘right’ stocks. But sadly you have no idea how to choose ‘right’ stocks!

This is where Mutual Fund comes in. Mutual Fund is a pool of assets (Stocks, Gold, Bonds) managed by an expert called ‘Fund Manager’. Fund Manager will gather money from investors like you and invest it in ‘right’ stocks. In return, he will charge a fee called ‘Expense Ratio’ (more on that later).

Mutual Funds are divided in 3 types based on Assets they invest in. This mind map will help you understand it better.

Debt Fund: Mutual Fund which invests majorly in Bonds
Equity Fund: Mutual Fund which invests majorly in Stocks
Gold Fund: Mutual Fund which invests majorly in Gold

Let’s focus on Equity Mutual Fund. In this, Fund Manager will do his stock research and choose ‘right’ stocks. But why is this ‘Equity Mutual Fund’ again divided in two types? Here’s the deal:

In ‘Active’ type, Fund Manager has liberty to buy stocks that he thinks are good. But in ‘Passive’ type, Fund Manager has follow a strict ‘Framework’ for choosing stocks. This framework is also known as ‘Market Index’.

But what’s Market Index? It’s a group of stocks representing state of Market. Here, Nifty50 represents top 50 companies in Indian Stock Market. In other words, These 50 companies are the largest and most trusted companies in India.

Think about it. A Mutual Fund which will only invest in India’s top 50 companies.

But why even bother to invest in top 50 companies through Mutual Fund? Why not directly invest in them on our own? Well…the reason is, You don’t have to maintain your stocks if you buy them through Mutual Funds. The Fund Manager will take care of your dividends, stock splits etc. on your behalf.

Now let’s see how to choose an Index Fund. Choice of Index Fund depends on 4 major parameters & those are listed below.

Expense Ratio: Fee charged by Fund Manager for managing your stocks. (Should be low as possible)

Tracking Error: How effectively the Fund Manager is able to mimic the index. (Should be low as possible)

Fund Size: Total amount of assets managed by Fund Manager. (Larger the better)

Exit Load: Penalty charged for exiting the Mutual Fund. (Should be low as possible)

After considering these 4 parameters, You can choose your Index Fund.

Just like Nifty50 Index Fund, There are other Index Funds such as Sensex Index Fund, Nifty Next50 Index Fund etc. You can invest in them according to your risk appetite.