What Is An Index Fund?
An index mutual fund is a sub-category of mutual fund, it has a portfolio built to replicate or follow the components of a financial market index. A mutual fund that tracks indices is considered to offer low operating costs, broad market exposure, and minimal portfolio churning. No matter how the markets are performing, these funds do not deviate from the portfolio of their benchmark index. Index funds are a safe shelter for retirement money, according to legendary investor Warren Buffett. He has stated that it makes more sense for the typical investor to purchase all of the S&P 500 companies at the cheap cost that an index fund offers rather than choosing specific stocks for investment.
An index mutual fund, as its name implies, makes investments in stocks that imitate stock market indices like the NSE Nifty, BSE Sensex, etc. These funds are passively managed, which means the management doesn’t alter the portfolio’s composition and instead invests in the same assets that are present in the underlying index in the same proportion. These funds aim to provide returns that are near identical to the index they follow.
How Index Funds Work?
Suppose there is an index fund that tracks the NSE Nifty Index. There will be 50 stocks in this fund’s portfolio, all unitholders of the mutual fund will be allocated in the same way. Along with bonds, an index may also contain equity and securities related to equity. The index fund makes sure to invest in each and every security that the index tracks.
A passively managed index fund attempts to replicate the returns provided by the underlying index, whereas an actively managed mutual fund strives to surpass its underlying benchmark.
What Is Nifty 50 Index Fund?
The NIFTY 50 is an index of the country’s top 50 companies by market capitalization that are listed on the National Stock Exchange (NSE). One of the two most popular indicators that investors use to gauge how the “stock market is doing” The other is the Sensex, which similarly tracks 30 stocks and is run by the Bombay Stock Exchange (BSE). When someone says “the market was up today,” they typically mean the NIFTY 50 index was up, despite the fact that there are 1,300 stocks listed on the NSE. Additionally, this indicates that the weighted average performance of those 50 stocks increased. The NIFTY movement is the primary point of reference for foreign investors monitoring the Indian markets, and their initial investments in India are typically made in NIFTY equities.
The Nifty Index fund is a type of mutual fund that follows the Nifty 50 index by purchasing shares of the firms that make up the index and attempting to use a “passive” investment approach to generate returns identical to the Nifty 50 Index. The fund manager must follow the index because the investment is passive. As soon as a modification to the constitution becomes effective, the fund portfolio must be updated appropriately. These funds have a passive investing technique, which results in lower management fees and, as a result, a lower Total Expense Ratio (TER) than active mutual fund schemes. It enables investors to produce investment returns that are in step with the portfolio’s benchmark Index.
The same process that is used to invest in other mutual fund schemes can also be used to invest in the index funds tracking Nifty. Mutual funds carry out the redemption and investment operations in index funds at the current NAV (Net Asset Value). One of the key reasons why the Nifty is regarded as a reliable indication of the success of the stock market is that it includes companies from 14 different sectors. As a result, an investor who places money in the Nifty 50 index has access to a diverse group of companies, which significantly lowers investment risk.
6 Reasons That Make Nifty Index Special
Sizeable Returns Over The Long Term
Historically long-term investing is best served by index funds like index mutula funds tracking indicies like Nifty 50. A 10-year investment horizon will probably average out market fluctuations and yield sizable returns.
To reduce investment risk, every investor tries to diversify his or her portfolio. A index fund tracking Nifty 50, achieves this goal by investing in the stocks of constituent of the Nifty 50 Index from a range of industries.
High-Quality Portfolio Constituents
Stock indices like the Nifty 50 regularly update their constituent stocks by substituting well-performing stocks for underperforming ones. As a result, the fund manager buys and sells the same securities to maintain consistency among the components of the portfolio. As a result, investing in this scheme carries a relatively lower risk.
Lower Expense Ratio For Passive Funds
Every mutual fund typically keeps a certain portion of your total investment to cover operating costs. This cost is known as the TER (Total Expense Ratio), and you can find out more about it in the scheme information document that applies to you or on any website that discusses the plan. As passive investments, index funds often have lower expense ratios than active mutual funds.
No Bias In Investing
A NIFTY 50 index fund investment is made via an automated, rule-based investment process. The fund manager has a clear mandate on which equities to purchase and in what quantities. By eliminating human bias from the decision-making process, the fund might be a great addition to your portfolio.
No Need To Be Concerned About Rebalancing
Your money is handled by a fund manager who keeps the portfolio in the exact same ratio as the NIFTY 50 index when you invest in a index fund tracking Nifty 50. The fund manager decides whether to increase or decrease a stock’s weight. Therefore, you don’t have to worry about rebalancing your portfolio or keeping your stock holdings in exactly the same ratio as the NIFTY 50 index.
How Are Stocks Selected To Be Part NIFTY 50?
There are certain sets of rules that decide which 50 stocks should be part of the NIFTY 50 index. Here are some of the rules and criteria on which the construct of NIFTY 50 is based:
- Universal: A company must be listed on the National Stock Exchange in order to qualify for inclusion in the NIFTY 50. (NSE). Additionally, a company’s stock should be accessible for trading in the futures and options portion of the NSE. The company cannot be a component of the NIFTY 50 if it is not listed and traded on the NSE.
- Basic Construct: The top 50 large-cap businesses from the NSE universe are chosen based on their free-float market capitalization. The market capitalization of a company that has free float is determined by multiplying its stock price by the number of shares that are currently on the market. The market capitalization of a firm, for instance, would be Rs. 30 lakh if it had 1 lakh easily accessible shares in the market at Rs. 30 per share.
- Liquidity: A stock’s liquidity is an important consideration when deciding whether to include it in the NIFTY 50 index. This means that equities that are a component of the NIFTY 50 index must be simple to purchase and sell, and they must also have a large trading volume.
How is NIFTY Computed?
The Nifty 50 Index is calculated using both a market capitalization-weighted method and a float-adjusted method. The index level displays the total market value of the shares that have been included in it for a specific period of time. Nifty’s base period begins on November 3, 1995. The base value and base capital of the index are both taken to be 1000 and ₹2.06 trillion respectively. The index’s value is determined using the following formula:
Value of Index: (1000 * Base Market Capital) / Current Market Value
Corporate actions such as rights issuance, stock splits, and other modifications are also taken into consideration. Since NIFTY serves as the benchmark by which all Indian equity share markets are measured, it frequently acts as the barometer of not only the Indian stock market but also that of the Indian economy. This shows the quality of assets which constitute Nifty 50.
How To Invest In The Nifty Index?
Since it is an index, we cannot buy it directly like a company’s shares. There are other methods to use the index to make money off of its changes, though. Your investment in the Nifty index can be made in one of two ways:
- Mutual Funds
- Investing in Nifty Through Futures Contracts
Investing In Nifty Via Mutual Funds
The same stock portfolio that makes up an index like the Nifty is featured in index mutual funds. As a result, these funds can effectively follow an index’s performance, enabling investors to benefit from the index’s ability to create wealth. In contrast to other mutual funds, index funds are more reasonably priced, provide better diversity, and have a higher likelihood of giving investors positive returns. By investing in Nifty index funds, you would essentially participate in each of the 50 parts that make up the Nifty 50 index, giving you exposure to a wide range of stocks.
Now that this idea has been clarified, let’s explore it further and attempt to comprehend how you can trade in Nifty using futures and options contracts.
Investing in Nifty Through Futures Contracts:
If you think the Nifty index will go up or down, you can use index futures contracts to make money from the price changes. Consider the scenario where the Nifty is trading at 12,000 on November 1st, 2021. Since you have an optimistic outlook, you predict that the index will increase to almost 13,000 by the expiration.
All you have to do is pay 12,000 for the Nifty NOV FUT contract. You can easily square off your position if the index advances as predicted and reaches 13,000 before the contract expires.
In the same way, let’s say you have a bearish view and think the index will fall to around 11,000 by the end of the contract. In this instance, selling short the Nifty NOV FUT contract at 12,000 is all that is necessary. You may easily square off your position and profit if the index moves as predicted and drops below 12,000 before the contract expires.
Important things to consider before investing in Nifty 50 Index Funds ?
- Investment Purpose:
As previously stated, the primary purpose of index funds is to replicate the market’s performance. As a result, they are not appropriate for investors looking for returns that outperform the market. Therefore, before investing in a Nifty 50 Index Fund, investors must decide what their financial objectives are. For investors whose goal is to replicate the performance of the market, index funds are a great choice.
- Tracking Error:
Tracking error is the difference between an index fund’s returns and those of the benchmark index. As a result, this indicator shows how successfully the Index Fund has followed the fluctuations of the underlying benchmark. As a result, the Index Fund performs better the lower the tracking error.
- Expense Ratio:
The expense ratio is an annual fee charged to investors by fund houses to cover the costs of operating a particular fund. These charges include things like management fees and advertising costs. The net annual returns that an investor receives are directly impacted by this yearly charge. Therefore, before investing in index funds, it is essential to take this factor into account.
Although investing in Nifty derivatives is one of the most effective trading strategies, it is more of a short-term approach. This is so because there is a three-month limit on the longest you can invest in a derivative contract. Derivatives are also considered riskier and necessitate active performance monitoring. Investing in a Nifty index fund would be the finest choice if you’re seeking for a long-term Nifty trading plan with minimal risk and little to no requirement for routine monitoring.
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