How to Choose Best Index Fund:Index funds are considered to be an easy and comparatively low-risk option for investing in equity i.e. stocks. Different index funds track the performance of different indexes of the stock market. But sometimes it is not easy for investors to choose the right index fund. Especially in those situations, when there are many options available in the market that track the same type of index. In such a situation, what things should a smart investor keep in mind while choosing the best index fund for investment?
Be sure to pay attention to these two parameters
Actually, while selecting the right index fund for investment, the two most important things or parameters to pay attention to are: 1. Expense Ratio and 2. Tracking Error. After understanding both these parameters properly, you will be able to make a better decision while choosing an index fund.
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Why is it important to pay attention to expense ratio?
While investing in an index fund, the first thing you should pay attention to is the expense ratio of that fund. Expense ratio is the fee that the mutual fund house charges from investors.
Lower expense ratio means more profit: Funds with lower expense ratios give higher returns in the long term because their fees are lower. For example, if one fund charges 0.10% and another fund charges 0.25%, the former will have better returns, provided the two funds are similar in all other respects.
Save Costs, Increase Returns:When you invest for a long time, even small expenses can affect your returns. So, always choose funds with low expenses.
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It is also important to understand tracking error
Tracking error means the difference between the performance of an index fund and the performance of its benchmark index. While choosing the right index fund, it is also important to consider this difference.
Less tracking error means more accurate results: If the tracking error of a fund is low, it means that the fund is tracking its benchmark index accurately. This gives the investor returns equal to or very close to the index.
The importance of being accurate: The main purpose of an index fund is to accurately track its benchmark index. Therefore, you should choose a fund that has a low tracking error to take full advantage of market fluctuations.
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Consider these things before investing in an index fund
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Avoiding complications: Index funds are better for those investors who want to avoid the complexities involved in investing in the stock market.
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Simple and stable returns:Index funds directly follow a particular index, which makes investors less worried about the fluctuations of the stock market. These funds give returns equal to or slightly higher than the average performance of the market over the long term.
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Low risk, high profit: Index funds have low risk because they are highly diversified as they track the entire index.
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The advantage of low cost:Being a passive fund, the expense ratio of index funds is generally lower than active funds, which has a positive impact on the overall returns.
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Make investment decisions carefully
If you are thinking of investing in an index fund, keep in mind that like most equity funds, index funds are also suitable for those investors who want to invest for the long term. Also, do not forget that due to investing completely in equity, there is a lot of market risk in them. Even though this risk is less compared to investing directly in stocks, but the fluctuations of the market have a direct impact on them. Therefore, only those investors should invest in index funds who have the ability to take risks.
