What is Index Fund?
A index fund are basically funds that invest in securities included in a particular index and just replicate that particular index, in same proportion and in same portfolio composition.
They give same return as the index they are tracking gives.
For Example: A index fund tracking NIFTY or SENSEX, invest in securities present in these funds and in same proportion as they weigh in Index.
There are so many index fund even one for every sector like banking, Pharma etc., you can invest in them through your stock broker and can diversify your portfolio. They bear very low expense ratio as their work is only to replicate the index.
Why people invest in Index Fund?
- Unlike conventional Mutual funds where you have a professional team of experts and research team analyzing securities and making recommendations, the index funds just replicate the designated index.
- Lower cost as the changes in them only happens in case there is change in index fund structure which is not very often, leading very lower operational cost in long run.
- Automatic Re-balancing as when there is change in Index which fund is following.
- They are easy to manage, portfolio manager just have to replicate the index and their job is done.
Factors to be considered while investment in Index Fund
Expense ratio of index fund varies with Index fund to Index fund, so investors should check the expense ratio before investing, although it is very low in case of Index funds between 0.3 – 0.6%.
Taxation of Index Fund
The returns from Index fund is subject to tax and falls under purview of Capital Gain. Same are taxed on the basis of period of your holding and accordingly treated as long term or short term – according to investment period.
Short Term capital Gain: If your holding period is less than 1 year, then Cap gain arises would be taxable as per your income tax slab you falls in, that could be 5%, 20% or 30%.
Long term capital Gain: If your holding period is greater than 1 year, then cap gain arises would be taxable @ 10% (NIL tax for Long term cap gain upto Rs. 1 Lakh).
As there are always a risk associated in conventional Mutual fund that any wrong decision by portfolio manager can put your principal investment amount on risk, same is eliminated in Index funds, as they move along with Index they are following and you are not dependent on decisions of portfolio manager.
These are suitable for medium risk taking investor looking at an investment period of 3-5 years.
You need to analyze funds from different angles and perspective, mainly while dealing in sectoral index funds, as they are diversified only within a particular sector in different companies. There are various quantitative and qualitative parameters to determine the best index funds as per your requirements.