Why index funds are a great choice for long-term investors

Whenever we think of investing, we think of building a robust, balanced, diversified portfolio. One that will perform through bullish and bearish phases of the market. The thought of asset allocation also crosses our minds. You must be wondering if all this is a detailed process that needs constant monitoring and portfolio rebalancing, akin to active portfolio management.

You may have heard many finance experts say index funds are the way to navigate investing in equities for beginners. What if you can build a diversified and balanced portfolio without worrying about poor performance? Yes, you can if you invest in a group of passive funds. The term passive investment often indicates that it is about index funds only. But there are index funds and large/mid/small cap focused funds, various strategy passive funds and theme/sector based index funds. You also have commodities-
based and international index funds for investors looking at exposure to commodity or international stocks.

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Investing in a range of index funds can help build a compelling portfolio. There is a range of index funds available in India. It helps avoid constantly monitoring the portfolio and performance as it is directly linked to market movement. Investing in index funds helps avoid emotions and reduce the cost of fund management. If one's investment horizon is 20-30 years - index funds are the obvious way to go.

The wide range of index funds is available in India and can help solve the confusion of asset allocation. So let's look at the types of index/passive funds available for Indian investors. Large-cap index funds such as Nifty 50 index fund is the most common form of passive or index investing. The funds are invested in a way that they mirror the components of the Nifty 50 index. As a result, the NAV of the fund moves in proportion to the index. In the long run, the market may go up due to the overall growth in the economy. Even better, the Nifty index, or any other index for that matter, is rebalanced at regular intervals - ensuring the best stocks stay and the not-so-good are removed efficiently.

Nifty 500 index funds: For investors with a broader diversification – there is the Nifty 500 fund.The funds are invested in a way that replicates the Nifty 500 index. As a result, the volatility is lower than a Nifty 50 index. Still, the gains, too, are slower as it is an average of a large number of companies posting gains.

Mid and smallcap index funds are funds that invest predominantly in mid and smallcap companies that are part of the relevant index. Many investors aspire for higher returns – mid and smallcap companies predominantly offer high and higher returns. Therefore, investors should aim to allocate in these segments reasonably, even if investing passively.

Factor-based funds: For methodological/rule-based investors, there is factor-based investing that invests on the basis of some pre-defined characteristics and macroeconomic factors like size, value, quality, momentum and volatility.

Gold and silver fund of funds: This category is for investors looking for exposure in commodities and precious metals. They can invest in gold & silver funds instead of in physical gold, which includes the cost of buying gold, storage, etc. These funds charge nominal fund management fees for returns replicating the gains of gold, silver, or other relevant precious metals.

S&P 500 and Nasdaq 100 funds are funds that invest in US indices. These are good options for domestic investors looking to diversify into overseas equities. Investing in International funds helps benefit from overseas markets, particularly the US. It acts as a hedge against local/domestic equities too.

Asset allocation funds are a good fit for investors looking for complete asset allocation in one fund. It is a passive and diversified fund that invests in a range of asset classes.

Sectoral funds: These are thematic funds that invest in a particular sector. Investors looking for exposure in a particular sector can invest in these.

Debt fund: Lastly, debt funds invest in bonds and high-quality debt securities. These are good options to invest in a rising interest rate scenario like the current one.

(The writer is the president, Passive Funds, Motilal Oswal AMC)