Investors consider two key factors before taking any investment decision – the investment horizon and the risk involved. A special category of funds called index funds track a stock market index with the aim of replicating its returns in the long run. Are these funds good investments for the long term? Read on to know more!
How do index funds function?
Index mutual funds track the performance of a given benchmark index. Index fund investments can help you diversify your investment portfolio and thereby minimise risk. If you invest in an index fund that track NIFTY50, for instance, the fund will try to replicate NIFTY50’s performance by mirroring its composition.
Benefits of investing in index funds for the long term:
Here are the key benefits of investing in index funds for the long term –
- You can diversify your investment portfolio: As mentioned earlier, diversification is one of the major advantages of investing in index funds. You can invest your capital across several domains by choosing a high-performing benchmark index like Sensex or NIFTY50. This diversification comes with another benefit – reduced overall risk. Portfolio diversification can be very beneficial to the investor in the long term.
- Index funds are cost-effective: Index mutual funds are passively managed funds, thereby making them extremely affordable for all categories of investors. Index funds rely on market wisdom to take investment decisions and follow an automated investment method that is free of human bias. These funds have lower expense ratios when compared to other fund categories.
- These funds offer tax benefits: Index funds are generally more tax-efficient when compared to other mutual fund categories. As they have lower turnover rates, they generate fewer capital gains which translates to lower liabilities for investors. This benefit, too, can help investors save a considerable sum of money in the long term.
- You can easily manage your index fund investments: Unless you decide to change the asset allocation of your index fund investment, the fund’s composition remains the same as the index that it is tracking.
Points to consider while investing in index funds for the long term
You must consider the following points before investing in an index mutual fund for the long term:
- Check if the index fund can help you achieve your long-term financial goal: You must decide on a long-term financial goal before investing in an index fund for the long term. An example of a long-term goal could be – saving for your higher education in the year 2030, purchasing a house in the year 2030, saving for your retirement in the year 2065, etc. Online financial calculators can help you estimate the amount that you will require for your financial goal in the future by accounting for inflation. You must check if the index fund in question helps you achieve these goals.
- Analyse your risk appetite and returns-related expectations and invest accordingly: You must also assess your ability to invest in risky investments and your returns-related expectations before investing. Be sure to diversify your portfolio regularly to reduce overall risk.
In conclusion, index mutual funds are ideal for long-term investment as they help you diversify your portfolio and replicate the performance of a benchmark index over the long term. They are also affordable and tax-efficient investments.
