The Pros and Cons of Investing in an Index Fund

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What are Index Funds?

The funds created depending on the stock market indices are known as index funds. Sector-specific funds are index funds because they invest depending on a stock market or specific sector indices. The most common two examples of stock market indices are BSE Sensex and NSE Nifty. These indices cover large-cap Indian stocks and shares traded in the markets.

  • The BSE Sensex covers the 30 most active and liquid shares in the Bombay Stock Exchange, while the BSE 100 covers the 100 largest companies.

  • The NSE’s S&P CNX 500 covers 94 percent of total market capitalization and about 98 percent of the total turnover of the NSE.

  • The S&P CNX 500 is further disaggregated into 74 industry indices. There are many other indices in the market that are actively followed by investors from various sectors.

Index funds are based on the principle that funds cannot control or affect market sentiments. However, this assumption is not entirely "true". The market indices may affect the prices of shares. This is the reason why indices are so popular and actively followed in the share market. That means the index funds are based on the assumption that the markets are efficient and all the rules of efficient markets are applicable while investing in index funds.

Advantages of Investing in Index Funds

Following are some of the prominent advantages of investing in an index fund −

  • Index funds are cost-effective − Index funds do not need to be bought and sold like actively managed funds. The costs associated with index funds is much lower than the actively managed funds. Actively managed funds are managed by fund managers who keep track of the shares regularly. Index funds are automatically priced depending on market demand. So, index funds are less expensive than actively managed funds.

  • Low research cost − The research costs associated with index funds are lower than actively managed funds. The research costs of index funds are associated with the indices which need less research than actively managed funds.

  • Easy follow-up − As index funds are totally market-based, they are easy to follow up.

Drawbacks of Investing in Index Funds

Following are some of the drawbacks of investing in an index fund −

  • Index funds cannot outperform the markets and they can only follow the market trends. If the market crashes, the index funds will also crash along with the market.

  • Small investors may not be able to invest in index funds, as the index funds often require higher investments to subscribe to the best of shares in the market.

Conclusion

Despite having drawbacks, index funds are widely followed by investors for a balanced income and growth. As the indices are the most dependable factor in the share markets, many investors prefer to act depending on the indices. That is why the indices are so widely popular in stock markets.

raja
Updated on 25-Mar-2022 05:31:27

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