Index funds offer investors an opportunity to generate long-term wealth while also reducing the risk associated with more active investment strategies. They are investments that track a particular benchmark or index, such as the Nifty 50, and include the same proportion of stocks as is reflected in that benchmark. This means that the investments typically shift with the overall performance of whichever market or index it is based on.
But just like any other investment vehicle, knowledge is key to maximising returns and reducing risk. With that being said, here are some specific strategies that can help you get the maximum return on your index funds investments.
- Understand your risk tolerance level
While index mutual funds are considered generally low-risk investments due to their passive nature and diversification benefits, they still expose you to some amount of risk that depends on the types of securities held within the fund. The risks associated with index funds are directly correlated with the benchmark against which the fund is measured.
For example, if you select an index fund composed of stocks/equities, it will inherently carry a higher level of investment risk than one that holds bonds.
- Do extensive research and compare different funds
Examining a fund’s track record, fees, past returns, tracking errors, etc., can help you determine whether it meets your risk tolerance, investment goals, and return expectations. Narrow down the top-performing index funds in India that have consistently delivered good returns (at least 4- 5 years) and choose the right one accordingly. Furthermore, it may be beneficial to consult a financial advisor to gain insight from an expert on what index might work best for you and your particular goals.
- Select a fund with a low tracking error and expense ratio
Tracking error measures how closely a fund tracks an underlying index. A fund with a low tracking error indicates that it closely follows the market. Similarly, a fund with a low expense ratio can increase the return on your investment over time since more of your money will be invested in assets instead of going towards administrative fees.
- Stay up to date on market trends
It is important to stay up to date on market trends when investing in index funds. Doing so allows you to make informed decisions about where and how much to invest in different sectors or stocks within an index fund. The stock market can be unpredictable and keeping an eye on current trends can help you make wise investment decisions based on current conditions rather than relying solely on historical data or predictions about what might happen in the future.
Closing thoughts
Investing in index funds can be a cost-effective way to diversify your mutual fund portfolio and get exposure to different asset classes and securities, but make sure to use strategies that suit your investment goals.
Also, it is recommended to stay invested for a longer period, at least five years, to maximise the gains – this allows time for any short-term fluctuations in the market to even out over time. You can even set up a systematic investment plan (SIP) to invest regularly for a longer time without overextending your budget. This allows you to reap the benefits of long-term investing while navigating market volatility and maintaining consistent growth.
