Wealth Guide: Are you a first time investor? Heres why Index Funds should be on your buy list

The key to having a smooth financial journey is to start early, create a diversified investment portfolio, and stay disciplined.

However, following this can become a challenging task for both seasoned as well as new equity market investors.

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A few of the challenges that first-time investors face at the beginning of their equity investing journey include the inability to select the right stocks or time market ups and downs, difficulty in diversifying the equity portfolio across different sectors, industries, and market capitalisations, and an inability to optimally deal with market volatility.

It can be argued that all investors must contend with the above challenges.

Chintan Haria, Head - Product Development & Strategy, ICICI Prudential AMC decodes the rationale behind investing in index funds:

However, for first-time investors, these challenges tend to get amplified. The best thing is that there are specific solutions like Index Funds, that can optimally address these issues for new to equity investors and help them optimally reap the benefits of equity investing.

What are index funds?

Index funds simply replicate the composition of an underlying index. This means that they buy all the securities that are present in an underlying index while ensuring that these are bought in the same proportion as the underlying index.

Take for example an index fund that is based on the Nifty50 index. Such an index fund will buy all the Nifty50 stocks and that too in the same weightage as the Nifty50 index.

In case there is a rebalancing in the Nifty50, the index fund will accordingly mimic the change in weightages.

By doing so, index funds can closely replicate the returns generated by the underlying index, subject to tracking error.

Moreover, an investor today has the option to choose from index funds based on Nifty, Sensex 30, Nifty Next 50, Midcap 150, Smallcap 250 and international options such as NASDAQ 100 to choose from.

How can index funds add value to your investment portfolio?

Index funds offer some specific benefits that can substantially help first-time investors harness the long-term growth potential of equities in an easy manner. Some of these include:

• Diversification: As mentioned, achieving optimal diversification, especially within the equity asset class can be a challenging task. However, benchmark indices are usually broad-based and cover stocks from multiple sectors and industries. Some of these are growth stocks, some are cyclical, and some are value plays. When you invest in an index fund, you automatically achieve a degree of diversification as your investment is spread across the different constituents of the underlying index.

• Lower costs: Generally, the costs associated with index funds are fairly low with the total expense ratio (TER) for an index fund capped at 1.5 percent by the market regulator Securities Exchange Board of India (SEBI). The lower costs stem from the fact that these are not actively managed and the transaction costs are also low since the churn is usually minimal.

• Returns in line with the index: Index funds are well-suited for investors who wish to generate returns in line with the index. This means that the risk that you take is only market risk and you avoid taking any additional risk.

• SIP Facility: Just like any actively managed fund, investors can opt for daily, weekly, fortnightly, monthly or quarterly SIP options.  

All of the above benefits make it easy for first-time investors to dip their toes into the equity market via an index fund.

But before investing do check if the fund matches your risk appetite, investment horizon, and financial goal.  

(Disclaimer: The views/suggestions/advices expressed here in this article is solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)