Investing in an index fund might sound a bit technical, but it isn’t. In fact, index funds investing is instead the most straightforward and hassle-free approach to investing. Let’s look at what economists and investment philosophers say about index funds.
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas,” says Paul Samuelson, one of the most influential economists of the 20th century and a Nobel Prize winner.
Even Warren Buffet is a fan of Index Funds. He has frequently advised that investing in index funds is one of the best things investors can do to build a long-term, diversified portfolio.
Lately, more and more people are investing in index funds. The index funds investing trend raises a crucial question:
Should you invest in funds that track specific benchmarks or those that cover the entire market?
To help you decide, let’s break down what index funds investing is, examine the main benchmarks in India, and compare the performance and risks of different indices.
What is an Index Mutual Fund?
An index fund is a type of mutual fund designed to match or track the performance of a specific financial market index. It achieves this by holding a portfolio that mirrors the components of that index. For instance, it might track major stock market indices like the BSE 30, Sensex, Nifty 50, or broader market indices like Nifty Next 50, Nifty Midcap 150, Nifty Small Cap 250, Nifty Micro Cap and Nifty 500.
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What Are Stock Market Indices?
Stock market indices measure the performance of a specific group of stocks listed on stock exchanges. The criteria for including stocks in an index depends on the type of industry, the size of the company, and its market capitalisation.
The stock market indices come in various types, including benchmark indices, sector-specific indices, broad-based indices or market capitalisation indices.
Benchmark Indices vs. Broad-Based Market Indices
Understanding the difference between benchmark indices and broad market indices is crucial when considering index funds in India.
Knowing their characteristics and advantages becomes pertinent when an index fund mimics either of the two.
Benchmark Indices: Your Market Health Barometers
In India, benchmark indices like the Nifty 50 and Sensex 30 are the key indicators of market health. These indices represent the crème de la crème of large, established companies that lead their respective sectors. Think of them as the VIPs of the stock market, which help you gauge the overall market performance and economic health.
Key Characteristics:
- Stable and Established Companies: Benchmark indices typically include blue-chip companies that are leaders in their industries. These companies are generally stable, financially sound, and less volatile.
- Lower Risk: Because they consist of large, well-established companies, benchmark indices are usually considered lower risk than indices featuring smaller or newer companies.
- Market Indicators: Benchmark indices are well-known and widely reported in the media. This makes them valuable indicators of market trends and the overall economic pulse.
Let’s dive into India’s top benchmark indices
Nifty 50
The Nifty 50, or simply Nifty, is the leading benchmark index in India. It tracks the 50 largest and most liquid companies listed on the National Stock Exchange (NSE). Investors, fund managers, and analysts closely follow this index to gauge the performance of the Indian stock market.
Sensex 30
The Sensex, short for Sensitive Index, comprises 30 well-established and financially sound companies listed on the Bombay Stock Exchange (BSE). Like the Nifty 50, it’s a key indicator of the overall health of the Indian stock markets.
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Broad Market Indices: Discovering the Market’s Full Spectrum
Broad market indices encompass a wider range of companies, including mid-cap, small-cap, and micro-cap stocks. These indices provide a more comprehensive view of the market by including companies of various sizes and sectors.
Key Characteristics:
- Diverse Exposure: These indices offer exposure to a wider array of companies, including those with high growth potential. While this diversity can lead to higher returns, it can also come with increased risk.
- Higher Volatility: Including smaller, less established companies means these indices can be more volatile, leading to greater fluctuations in returns.
- Growth Potential: With mid-cap and small-cap stocks in the mix, broad market indices often offer higher growth potential compared to benchmark indices.
Here are some broad-based indices:
- Nifty MidCap 150 captures the performance of 150 mid-cap companies, balancing growth potential and risk.
- Nifty Small Cap 250 covers 250 small-cap companies, representing high growth potential but with higher volatility.
- Nifty Micro Cap includes micro-cap companies, the smallest in market capitalisation, offering significant growth opportunities and considerable risk.
- Nifty 500 encompasses the top 500 companies listed on the NSE, providing a comprehensive snapshot of the market
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Past Performance of the Market Indices
| Index | Type | 3-Year Returns (%) | 5-Year Returns (%) |
|---|---|---|---|
| NIFTY 50 - TRI | Benchmark Index | 17.0 | 17.4 |
| BSE SENSEX - TRI | Benchmark Index | 16.4 | 17 |
| Nifty Next 50 - TRI | Benchmark Index | 24.7 | 23.4 |
| Nifty Midcap 150 - TRI | Broad-Based Index | 28.4 | 29.3 |
| Nifty Small Cap 250 - TRI | Broad-Based Index | 27.7 | 29.8 |
| Nifty500 Multicap 50:25:25 - TRI | Broad-Based Index | 23.1 | - |
| BSE 200 - TRI | Broad-Based Index | 19.8 | 20.1 |
TRI refers to the Total Return Index.
Data as of July 8, 2024.
Returns are compounded annually for periods exceeding one year and on an absolute basis for one year or less.
Comparing Performance
The broad-based indices have generally outperformed the benchmark indices over the last 3 and 5 years. These indices have given higher returns compared to benchmark indices, and all the index funds mimicking these indices would have generated high returns.
However, these increased potential returns come with higher risk and greater market volatility. The post-COVID market rally, which saw significant gains in small and midcap stock prices, contributed to the better performance of broad-based indices.
Here’s a look at the top 10 index funds on Kuvera, sorted by returns in the last three years. Remember, past performance is not an indicator of future returns.
Top performing benchmark index funds against a broad-based index funds
The data extracted is as of 18 July 2024
| Scheme Name | Index Name | 3-Year Return (%) | TER (%) |
|---|---|---|---|
| Aditya Birla Sun Life Nifty Midcap 150 Index Growth Direct Plan | Nifty Midcap 150 | 27.59 | 0.44 |
| Motilal Oswal Nifty Midcap 150 Index Growth Direct Plan | Nifty Midcap 150 | 27.55 | 0.30 |
| Nippon India Nifty Midcap 150 Index Growth Direct Plan | Nifty Midcap 150 | 27.32 | 0.30 |
| UTI Nifty200 Momentum 30 Index Growth Direct Plan | Nifty 200 | 26.70 | 0.46 |
| Motilal Oswal Nifty Smallcap 250 Index Growth Direct Plan | Nifty SmallCap 250 | 25.39 | 0.36 |
| Nippon India Nifty Smallcap 250 Index Growth Direct Plan | Nifty Smallcap 250 | 25.29 | 0.35 |
| Kotak Nifty Next 50 Index Growth Direct Plan | Nifty Next 50 | 24.32 | 0.35 |
| DSP Nifty Next 50 Index Growth Direct Plan | Nifty Next 50 | 24.20 | 0.30 |
| SBI Nifty Next 50 Index Growth Direct Plan | Nifty Next 50 | 24.13 | 0.33 |
| IDBI Nifty Next 50 Index Growth Direct Plan | Nifty Next 50 | 24.11 | 0.32 |
In Summary
Index funds investing can offer a simple, cost-effective way to participate in the stock market.
Whether you choose benchmark indices like the Nifty 50 and Sensex 30 for stability, or broad market indices like the Nifty MidCap 150 and Nifty Small Cap 250 for higher growth potential, It is better to align with your financial goals and risk appetite.
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Think of index funds like a well-balanced diet: benchmarks provide the essential nutrients needed for stability, broad market indices offer the variety and spice necessary for growth. Combining both can help you build a robust and resilient investment portfolio!
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Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
Watch here: Investing In Passive Funds
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DISCLAIMER: Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investments in securities market are subject to market risks. Read all the related documents carefully before investing. The securities quoted are for illustration only and are not recommendatory.
