How to Select the Right Index Funds for Your Portfolio?
Over the years, the popularity of index funds has risen considerably over the years. Assets under management (AUM) of index funds stood at ₹2.43 lakh crores as of June 2024, a surge of nearly 900% in assets over the last three years . Investing in index funds can aid you diversify your portfolio in a cost-effective manner. However, the real deal is to pick the best index funds for your portfolio.
What are Index Funds?
Before choosing the top index funds, let’s understand what these funds are. Index funds are mutual funds that track and aim to mimic a particular index, such as Nifty 50 or BSE 30. Index funds aim not to outperform the index but to replicate its performance. These funds hold securities in the same proportion as that of the index.
Choosing the Best Index Funds for Your Portfolio
Zeroing in on the top index funds for your portfolio is a culmination of several factors. Some essential things you should keep in mind are:
- Picking the Right Index
The first step is to choose the correct index. This is because different indices have different sector focus levels and market capitalisation. For instance, while large-cap indices such as the Nifty 50 comprise well-established companies, mid-cap indices such as the Nifty Midcap 100 consist of midcap companies with higher growth potential albeit more risk.
On the other hand, a global market index such as FTSE 100 comprises international firms and investing in an index fund tracking this index provides exposure to global companies.
- Checking the Fund’s Tracking Error
This is another crucial lookout while selecting the top index funds for your portfolio. Tracking error reflects the deviation between an index fund and benchmark index's returns, which it tries to mimic. A large tracking error indicates a significant deviation of the fund from the index.
On the other hand, a low tracking error shows the fund is closely mirroring the index. Choose funds with low tracking errors to ensure the fund's performance is close to the index.
- Look at the Fund’s Expense Ratio
Index funds command a lower expense ratio than active funds. This is because they don’t aim to outperform the index and don’t require active management. That said, the expense ratios of all index funds are not the same.
Go for a fund with a low expense ratio, as a high ratio can drag down overall returns. Even a slight difference in expense ratios could make a significant difference.
- Evaluate the Fund’s Long-term Returns
It’s vital to evaluate a fund’s long-term returns over 5 to 6 years. This will help you analyse how well a fund has performed across market cycles. Go for funds with a consistent track record that aligns with the performance of the index tracked. Compare returns with peers to get a clear picture.
Wrapping it Up
With several index funds available, choosing the best fund requires meticulous research and a holistic view of your goals. Index fund returns may not be high compared to some actively managed funds, but they can help you build a stable portfolio at a pretty low cost. Adopt patience and discipline with your investment to reap rewards in the long run.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.
