Index funds are mutual fund schemes that follow and duplicate the performances of stock market indexes to make investments comparably. As a result, the primary goal of an index fund is to replicate the market performance. The mutual fund sector in India offers several such funds. Some massive index funds follow the Nifty50 on the NSE and the Sensex on the BSE.
An index fund with such a Sensex strategy, for example, will include 30 equities in its portfolio, as Sensex does. A fund with a Nifty50 strategy, for example, can have 50 underlying equities. Furthermore, like with Sensex, the proportion of investments allocated to each stock will be the same.
The fund is passive since the allocation of money in the underlying equities mirrors the index funds. It simply implies that a fund manager will not have to manage the fund actively or do research on stock selection, holding, or sale to build the portfolio. As a result, such funds are designed to replicate rather than beat benchmarks.
What is your investment objective?
Have you heard this before? You most likely have! But did you sit down with a pen and paper and write out your short, medium, and long-term financial goals? When do you think you’ll need a specific quantity of money if you decide to invest it?
Are you going to need a portion of it in two years for a down payment on a car, five years for a down payment on a house, or would you need to take money out of your assets regularly to fulfill your travel goals? To achieve these goals, you may require a different investment vehicle or multiple stated periods, even in the same product.
How much time should you dedicate?
You could be the sort of person who spends a few hours each day fine-tuning your financial approach. Somebody with a high-risk tolerance may feel more at ease trading and observing the stock market regularly. On the other hand, mutual funds may be the ideal investment for you if you want to invest in goods that don’t need you to organize and control them all the time.
How do Index Funds work?
Index funds invest in a particular index or benchmark. An index defines a market sector. To put it another way, shares from the same section are grouped to form an index. These divisions are either equity-oriented products, such as stocks, or debt-oriented instruments, such as bonds. An index fund following NIFTY, for example, will own the same Nifty Small-cap 50 funds in the same proportion.
These funds follow a particular benchmark and hence fall under passively managed funds. The fund manager would not choose the stocks; instead, he would follow the example. The fund management team strives to keep the underlying benchmark’s composition consistent.
Taxes on Index Funds in India
The sale of index fund units is taxed as a capital gain. In addition, the tax rate is determined by the holding duration of the fund’s units.
Short Term Capital Gains (STCG) occur when the units are held for less than 12 months. The quantity of gain earned is taxed at a rate of 15%.
Long-Term Capital Gains (LTCG) occur when a unit is held for longer than a year. On the sum of gains earned, the tax rate is 10%, even without the benefit of indexation.
The goal of index funds is to replicate the performances of a benchmark. In the long run, a stock market index is beneficial to an investor. As a result, these funds are best suited to long-term investors, particularly those planning to retire. These funds are also a good choice for investors who want to know how much money they’ll make.
Since these products do not carry a high level of risk, they are an excellent choice for risk-averse investors seeking equity exposure. Index funds are also passively managed funds that don’t need portfolio management.
On the other hand, an actively managed fund has a portfolio based on the fund manager’s projections and carries some risk. Actively managed funds necessitate portfolio monitoring regularly.