As of 15 February 2023, the net worth of Warren Buffet was placed somewhere in the range of $100-110 billion. He, as you may well know by now, is one of the most (if not the most) prosperous investors of all time. The man’s style of investing, predominantly based on patience, discipline and value, has yielded all the results of success and stocks that have shone in the market. While all of us, regular investors, may not be able to afford the kind of investment that Mr. Buffet does, some of us may do well to follow a key suggestion of his: The benefits of index funds, low in cost, are worth taking seriously. In other words, Buffet states that investing in index funds is one of the smartest decisions you can make.
The Basics of Index Funds
Before you pay heed to Mr. Buffet’s valuable advice, you should know about the benefits of index funds. Even before this, you should have some idea of basic concepts related to index funds. To invest in an index fund, you do not have to open a demat account. So, what is an index fund? Plainly put, an index fund is a kind of exchange-traded fund (ETF) or a mutual fund which holds a representative sample, or all, of securities within a particular index. The goal of investing in such a fund is to match the fund's performance to the benchmark, the index. The most famous index in India, perhaps, is the NSE NIFTY, followed by the BSE SENSEX. In the USA, it is, perhaps, the S&P 500. There are index funds that are geared to every investment and market strategy investors can think of. It is possible to buy an index fund via a brokerage or directly from an AMC.
The Benefits of Index Funds
In case you are thinking of investing in stocks in order to diversify your financial portfolio, or perhaps, an upcoming IPO, you can think of index fund investment as well. Here are the main advantages that investors get while investing in an index fund:
- Returns - Index funds have historically outperformed any other kinds of funds in terms of the total returns they generate.
- Low Management Charges - A key reason for index funds to be low in management fees is that they are managed and run passively. Instead of any index fund with a fund manager who is actively transacting and trading, and research professionals analysing securities and recommending stocks, the portfolio of an index fund just aims to duplicate a designated index.
- Low Transaction Fees - An index fund holds all the funds within it till the time the index itself undergoes a change (and this does not take place very often). Due to this, index funds have a low cost for transactions. Low charges make a huge difference in terms of an investor’s returns/gains. This is especially true for investments made over the long term.
- Low Taxable Income - Index funds tend to trade within and out of securities with a lower frequency than funds which are actively managed do. Hence, they are prone to generate lower taxable income, which can be passed on to shareholders.
While making a note of the benefits of index funds, you should remember to select one with the lowest expense ratio. Compared to funds which are actively managed, index funds have low expense ratios overall, but some index funds display lower ratios than other index funds.
Wise Investment - The Best Investment
While you can probably see the many pros of index funds, you may still wish to open a demat account and invest in the stock market directly. An investment in a prospective upcoming IPO is a good idea to spread your portfolio. However, when you have diversification on your mind, you may want to consider that it is a “double-edged sword” of sorts. It can streamline volatility and risk, yes, but an index fund should be chosen wisely, as a few underperforming stocks can ruin the whole basket. 123
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