Most of us as investors know the benefits of diversification. Investments in different asset classes reduce risk. Index funds and mutual funds are often preferred by investors to diversify their portfolios. But usually investors want to know which option is better between mutual funds and index funds. Therefore, information related to this is being given through this article, which will make it easier for you to choose the better of the two.
Unlike mutual funds, index funds are not intended to outperform the market, but to maintain uniformity. These build your portfolio by tracking standard market indices like Nifty 50 or Sensex. The main objective of index funds is to replicate index performance and provide returns at low cost. Index funds provide returns while maintaining uniformity. By investing in it, investors can balance the risk and returns in their investment portfolio.
A mutual fund is a type of investment instrument. It involves depositing money from various investors to invest in the company’s shares or bonds. Mutual fund portfolios are shared by thousands of investors and are collectively managed by fund managers. This type of investment depends on the fluctuations of the market and provides as much leverage as possible. Mutual funds are a great way to raise money. These funds are registered with SEBI. Some actively managed funds have the ability to deliver market beating returns, provided the investor remains invested for a long period of 10 to 20 years. Investors willing to take risks can invest in actively managed funds.
Benefits of investing in index funds over mutual funds
- Index funds do not have minimum purchase criteria like mutual funds.
- Index funds are known to offer predictable returns at a minimum cost.
- They are more liquid than mutual funds.
- Some ETF funds have higher tax benefits than open-ended mutual fund schemes.
Index Funds vs Mutual Funds
Mutual funds are actively managed funds, so fund houses have to appoint professional stock pickers to manage the portfolio, helping to provide good returns to investors. Mutual fund houses pay these professionals and they bear this to investors. Thus many mutual fund houses charge high fees from investors based on the performance of the mutual fund portfolio. On the other hand, index funds do not incur very high fees in terms of fees. Rather than hiring professionals to provide high returns to investors, index funds only buy specific stocks and keep them in proportion to their importance in the index. For example, if index funds track a benchmark such as Nifty, its portfolio will have 50 stocks in the same proportion as those in the Nifty. Therefore, professionals in index funds do not spend much, so fund houses do not charge more than investors. Let’s take a look at the following factors, so that you can decide yourself which is better –
Annual expense ratios tend to be lower in index funds because they are passively managed, whereas investments in mutual funds have higher annual expense ratios, as they are actively managed by stock market professionals.
When it comes to risk factors, equity-related risk in index funds is lower, as they track an index. Funds that are actively traded have a greater impact on market volatility, as these companies invest heavily in equity. However, investors should invest in mutual funds during market downturn, as index funds may lose their value during market downturn. At the same time, in mutual fund investment you have the option to switch funds during market fluctuations. The fund manager ensures that you get the best return on your investment.
Index funds are known to deliver predictive returns by tracking the performance of the underlying benchmark. Their purpose is not to exceed the benchmark, but to perform equivalently. But the returns generated due to tracking errors may be less than the index. On the other hand, mutual funds are known to give market-beating returns. To reduce risk, returns are made by investing in different asset classes. When one asset is not performing well, the loss can be offset by another asset.