Investing In Index Funds.
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Advantage of investing in an index fund
An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions. Many index funds rely on a computer model with little or no human input in the decision as to which securities are purchased or sold and is therefore a form of passive management. Tracking can be achieved by trying to hold all of the securities in the index, in the same proportions as the index. Index funds capture asset classes in a low cost and tax efficient manner and are used to design balanced portfolios.
The lack of active management generally gives the advantage of lower fees and lower taxes in taxable accounts. In addition it is usually impossible to precisely mirror the index as the models for sampling and mirroring, by their nature, cannot be 100% accurate. The difference between the index performance and the fund performance is known as the 'tracking error' or informally 'jitter'.
Under NPS in the asset class E (equity) the fund managers are permitted to invest in BSE sensitive index and the Nifty 50 index.
The main advantages of an index fund are :
Low costs (for costs refer section in NPS features)
Because the composition of a target index is a known, it costs less to run an index fund. No highly paid stock pickers or analysts are needed as in case of an actively managed large cap fund.
Simplicity
The investment objectives of index funds are easy to understand. Once an investor knows the target index of an index fund, what securities the index fund will hold can be determined directly. Managing one's index fund holdings may be as easy as rebalancing every six months or every year.
Lower turnovers
Turnover refers to the selling and buying of securities by the fund manager. Selling securities in some jurisdictions may result in capital gains tax charges, which are sometimes passed on to fund investors. Because index funds are passive investments, the turnovers are lower than actively managed funds.
No style drift
Style drift occurs when actively managed mutual funds go outside of their described style (ie. mid-cap value, large cap income, etc) to increase returns. Such drift hurts portfolios that are built with diversification as a high priority. Drifting into other styles could reduce the overall portfolio's diversity and subsequently increase risk. With an index fund, this drift is not possible and accurate diversification of a portfolio is increased.
An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions. Many index funds rely on a computer model with little or no human input in the decision as to which securities are purchased or sold and is therefore a form of passive management. Tracking can be achieved by trying to hold all of the securities in the index, in the same proportions as the index. Index funds capture asset classes in a low cost and tax efficient manner and are used to design balanced portfolios.
The lack of active management generally gives the advantage of lower fees and lower taxes in taxable accounts. In addition it is usually impossible to precisely mirror the index as the models for sampling and mirroring, by their nature, cannot be 100% accurate. The difference between the index performance and the fund performance is known as the 'tracking error' or informally 'jitter'.
Under NPS in the asset class E (equity) the fund managers are permitted to invest in BSE sensitive index and the Nifty 50 index.
The main advantages of an index fund are :
Low costs (for costs refer section in NPS features)
Because the composition of a target index is a known, it costs less to run an index fund. No highly paid stock pickers or analysts are needed as in case of an actively managed large cap fund.
Simplicity
The investment objectives of index funds are easy to understand. Once an investor knows the target index of an index fund, what securities the index fund will hold can be determined directly. Managing one's index fund holdings may be as easy as rebalancing every six months or every year.
Lower turnovers
Turnover refers to the selling and buying of securities by the fund manager. Selling securities in some jurisdictions may result in capital gains tax charges, which are sometimes passed on to fund investors. Because index funds are passive investments, the turnovers are lower than actively managed funds.
No style drift
Style drift occurs when actively managed mutual funds go outside of their described style (ie. mid-cap value, large cap income, etc) to increase returns. Such drift hurts portfolios that are built with diversification as a high priority. Drifting into other styles could reduce the overall portfolio's diversity and subsequently increase risk. With an index fund, this drift is not possible and accurate diversification of a portfolio is increased.