Financial Planning With Index Funds
With the number of index schemes on the rise, you can find an alternative to all major active mutual fund categories. There are large-cap, mid-cap, and small-cap index funds. You can even find a replacement for the multi-cap and Flexi Cap categories. If you want to take exposure to sectors, some ETFs track sectoral indices like Information Technology, Healthcare, Auto, etc.
With so much variety available, it’s easy to rely on index funds for your entire financial planning.
Let’s look at each category of equity funds and their index fund alternatives.
Large Cap Index Investment Options
In the large-cap space, passive funds track six indices. These include three from NSE and an equal number from BSE.
Performance Of Large Cap Indices
To understand how each index has performed, we looked at the rolling returns for 15 years. Rolling returns will tell you what could have been your returns if you had entered for a three- or five-year period in the past decade and a half.
Data shows the NIFTY NEXT 50 index has offered the highest returns. However, it can be volatile in the short term (three years) – it could fall more than other indices.
Should you then invest in NIFTY NEXT 50 when choosing a large-cap index fund? A better option will be to split your investments in NIFTY 50 and NIFTY NEXT 50. If you do this, you don’t need to invest in the NIFTY 100 or SENSEX 100 indices, as they have the same stocks as the other two indices.
Broader Market Index Funds
Investors looking at a broader and more diversified index to invest in have three options. These funds are an alternative to actively managed multi-cap funds.
Performance Of Broader Indices
In the long term, the NIFTY 500 has offered better returns than the other two indices. However, the Nifty LargeMidcap 250 Index can be slightly less volatile than the other two due to the absence of small-cap stocks.
Mid-Cap Investment Options
Mid-cap indices typically have 150 companies. However, some funds only look at the top 50 mid-cap companies. That gives investors three options.
Performance Of Mid Cap Indices
Without a doubt, Nifty Midcap 150 is one of the best indices among the mid-cap. It is less volatile than others while generating better returns. It is valid for the short as well as the long term.
Small Cap Index Investment Options
In small-cap indices, too, investors can choose from two different options. One index covers all 250 small-cap companies. The other focuses on the top 50 small-cap stocks.
How To Choose the Right Index Fund For You?
If you are looking at index investing, it’s better to go with a broader index than select a few stocks in any segment. Therefore, avoid indices like Small Cap 50 and Mid Cap 50.
If you compare the small-cap index with the mid-cap index, you will realize why the small-cap should be tactical. Nifty Midcap 150 index has an average return of 14.54% in five years, higher than the small-cap index. It also fell less in different market conditions. Therefore, the concept of high-risk, high reward doesn’t seem to hold when it comes to small-caps.
Conclusion
When investing in index funds, you must be careful about the fund and the category you pick. The good news is that if you are a passive investor, you have index fund alternatives to major equity categories. You can now build a portfolio using only passive funds. Before selecting a fund, compare the tracking error and expense ratio.
