The cost efficiency of index funds

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The cost efficiency of index funds

You can invest in several mutual funds depending on your investment objective, risk appetite and financial goals. Passive funds are an excellent choice if you’re looking for an affordable and diversified portfolio. Among passive funds, you can invest in Exchange Traded Funds (ETF) or index funds. Both of these are structured to replicate the performance of an index that they track, without the influence of a fund manager.

Investing in an index fund like the NIFTY index fund has several benefits, including low operational costs. Read on as we discuss the affordability of index funds and their benefits.

How does an index fund work?

An index fund is a type of mutual fund that passively tracks the performance of a benchmark index. It can track any asset, security, commodity, etc. Index funds have lower operational expenses than actively managed funds because of their passive nature.

Benefits of index funds

Index funds offer extensive portfolio diversification and have a low expense ratio compared to active funds. A few other benefits of investing in index funds like the NIFTY Next 50 index funds include:

1. Passive management

Mutual funds are managed actively or passively. In an actively managed fund, the manager usually buys or sells stocks or other assets regularly to beat the market. In such cases, there is often a risk of fund managers’ poor decisions, which could eventually underperform the benchmark, especially over a long duration.

However, in the case of a passive fund such as an index fund, the manager seeks to purchase and hold the securities that represent the constituents of the given index. 

2. Low expenses

Index funds are among the most affordable funds because of their passive nature. The cost of managing the funds is low since they do not require extensive market research and analysis, which an actively managed fund requires. 

The saved costs help investors. When choosing an index fund, look for funds that offer a low expense ratio. A lower expense ratio ensures decent returns in favourable market conditions. Due to low expenses and better returns, they may also outperform the actively managed fund.

3. Tax saving

For long-term capital gains on equity index funds, returns are taxed at 10% after the initial exemption of ₹1 lakh yearly. Short term capital gains on equity index funds are taxed at 15%. For non-equity index funds, the returns are taxed as per the income tax slab. 

4. Extensive portfolio diversification

In addition to cost-effectiveness, index funds also provide several investment options to diversify your portfolio and mitigate the risks of the volatile market. Depending on your investment objectives, you can select your sector, industry, and assets to diversify your portfolio.

Due to their low expense ratio and low minimum investment amount required, index funds can be a cost efficient investment for investors.