Which is the most beginner friendly investment instrument in India? The question can get you many different answers depending on who you ask. But today we are arguing in favor of index funds as the most beginner friendly investment option.
Before we explain why you should invest in index funds, let us understand what are index funds;
An index fund is a type of mutual fund where the portfolio is meant to replicate a specific benchmark, such as the Nifty50, and hence has the same amount of assets in the same proportions as the Nifty. BSE Sensex and NSE Nifty are two of India’s most popular indicators. Index funds are referred to as passively managed since they duplicate a certain index.
Back in the 1970s, passive investing, especially via index funds, was popularised in the US by the Vanguard Group that was created by John Bogle. Since then, index funds have literally swept the mutual fund market not just in Bogle’s home country, but also across other developed markets such as Europe and Japan. Since the early 1990s the move towards passive index investing across these developed markets was further intensified with the widespread emergence of Exchange Traded Funds or ETFs.
Over the past few years, a similar trend is visible in India. Between the end of March 2017 and December 2023, the assets under management (AUM) of index funds in India increased by 81 times, from a little more than Rs 2,450 crore to a shade below Rs 2 trillion, according to data from the Association of Mutual Funds in India (AMFI). In the same period, the AUM of ETFs went up from Rs 50,200 crore to more than Rs 6.5 trillion.
Another smart way for long term wealth building is through SIP (Systematic Investment Plan). SIP offers a simple and low-effort method to build wealth gradually over time.
Coming to what makes index funds so beginner friendly? Here are a few reasons why index funds are a great beginner friendly investment option;
- Diversification & market representation: Index funds typically track a broad market index, providing a great degree of diversification across multiple stocks or assets. Therefore, an investor gets a robust portfolio that is diversified across companies, sectors and market cap. The broader market exposure extends to fixed-income indices as well that cover assets such as government securities, T-bills, corporate bonds, commercial papers etc.
- Index funds are also governed by the regulators such as RBI and SEBI to safeguard the best interests of the investors; these indices provide for a well-defined, market-relevant and rules-based framework.
- Cost efficiency: Index funds also have the advantage of being low-cost. Since the underlying securities in the portfolio replicate the benchmark that it tracks, the fund manager is not actively involved in buying/selling of securities.
Therefore, index funds have lower fees and expenses than actively managed funds.
- Rebalancing: Index funds leverage market wisdom by following an automated and well-regulated investment method that is free from human or emotional bias. Since they mirror the asset allocation of the benchmark, the portfolio remains aligned with the index and reduces the need for frequent adjustment basis volatility.
- Innovative opportunities: With index funds you can invest in innovative sectors like AI or renewable energy while safely diversifying your portfolio. You can choose specific sectors, themes or market cap to invest in through index funds.
- Transparency: All investors greatly appreciate transparency of where their money is going. Since index funds only allow for companies listed on a particular index to be a part of the portfolio, the investor knows the exact composition of the underlying assets in the fund.
Not only does this help in promoting transparency but also makes it easier for the investor to understand and track his/her portfolio.
- Long-Term Growth Potential: With a focus on long-term growth, index funds allows beginners to build wealth steadily over time, achieving their financial goals smoothly.
- Low Entry Barrier: Index funds require minimal initial investment, making them accessible to individuals with limited capital looking to enter the investment market.
- New opportunities: Investing in index funds provides beginners with an educational opportunity to understand market dynamics, risk management, and portfolio diversification, laying a strong foundation for their financial journey.
- Low Expense Ratio: Index funds are passively managed, which typically results in lower expense ratios compared to actively managed funds. This makes them a cost-effective option for investors who are looking for exposure to certain sectors like the financial services sector without the need to select individual stocks.
Investing in an index fund eliminates the need for day-to-day market tracking, understanding market conditions, and conducting stock research.
Index funds offer all the necessary benefits like the stability, passivity, diversification and low-cost advantages that a beginner investor should look out for. So, are you convinced that index funds are great for beginner investors?
Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
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