FINANCE

Index Funds: How Do They Work And What You Should Know Before Investing

Investors who opt for index funds enjoy a hassle-free experience as these funds demand minimal monitoring.

For investors seeking a balance between low risk and substantial returns in the stock market and mutual funds, index funds emerge as a viable solution. With this option, investors can avail benefits of minimal monitoring and avoid concerns about market fluctuations. Specialist Balwant Jain highlights the merits of index funds in the investment landscape. These funds follow a diversified approach, investing across all companies listed on the entire exchange. He offers advice to investors seeking favourable returns with less risk, suggesting the inclusion of index funds in their investment portfolios.

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How does an index fund work?

Index funds serve as mirrors to financial exchanges, with notable examples being NSE Nifty and BSE Sensex. Despite a pool of around 627 companies listed on the NSE, Nifty strategically handpicks the top 50 best-performing companies for its fund’s exclusive investments.

Similarly, in the case of BSE, which boasts approximately 2,600 listed companies, the Sensex index focuses on the cream of the crop — the top 30 companies — allocating its funds accordingly. This approach ensures that index funds track and invest in a curated selection of high-performing companies within a specific exchange.

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Investors who opt for index funds enjoy a hassle-free experience as these funds demand minimal monitoring. Unlike traditional equity funds that often necessitate portfolio adjustments from investors, index funds automatically weed out underperforming companies from their list. This feature serves as a key advantage, significantly lowering the associated risk in these entirely equity-based funds.

In 2023, both Nifty and Sensex experienced a significant uptick of approximately 20% in the stock market. Looking ahead to 2024, experts predict a potential increase of over 15% on both exchanges. Shifting focus to index funds, a financial tool with roots dating back to its inception in 1957, it has delivered an average annual return of 10.26% until 2023. For investors with a long-term horizon of 7 years or more, financial experts suggest the possibility of securing a stable return ranging between 10 to 12%.

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Key Index Fund Performance:

  • LIC MF Nifty Next 50: Notable 16% returns in the last 10 years, impressive 30% in the past year.
  • ICICI Prudential Nifty Next 50: Solid 16% returns over the last decade, a significant 30% in the past year.
  • Sundaram Nifty 100 Equal Weight: Respectable 13% returns over 10 years, impressive 32% in the last year.
  • ICICI Prudential Nifty Next 50 (5-year): Substantial 15% returns over 5 years, commendable 30% in the past year.
  • UTI Nifty Next 50 (5-year): Impressive 15% returns over 5 years, noteworthy 30% in the last year.

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