What was once termed as “Bogle’s Folly” has today become an integral part of the financial portfolio of investors across the world. Yes, we are talking about index funds which have picked up pace ever since its inception in August 1976. John C. Bogle, founder of Vanguard, an American Asset Management Company, was the first person who proposed the idea as well as initiated the very first index funds. It was his vision that his clients should be able to build wealth through passive equity management that was rejected by most people back in the day. It was Vanguard who opened the very first index funds now known as Vanguard 500 Index Fund which is one of the largest index funds in the world.
With its minuscule costing and higher returns than normal equity funds, index funds ultimately revolutionized the mutual fund industry.
But exactly what are these index funds?
An index fund is a type of a passive mutual fund where instead of a fund manager making decisions about which stocks to choose for you, the fund mimics the performance of the index. So your investment is not restricted to any emotional decisions made by investment managers and solely depend on the performance of the index you are investing in.
Generally, when we purchase a normal active fund, we entrust our money to a fund manager and ask him to buy or sell the stocks for us according to his or her expertise. But when you invest in an index fund, you are telling the fund manager to invest in the companies that are a part of a particular index in the exact proportion as the weight of the stocks of these companies have in that index.
How is index fund relevant in Indian context?
Let us understand ‘what is index fund’ in the Indian context to have a clear understanding of this concept. The two major indexes in India are NIFTY and SENSEX. SENSEX is an index indicative of the market value of 30 companies where each one of them has a dedicated proportion of share in the index. So for example, if you invest in a SENSEX index fund, your fund will also invest in the stocks of the companies that are in the SENSEX. Depending on the rise or fall of these stocks, the index will move and that will reflect in your index fund’s performance. Your daily gains and losses will solely be in line with the performance of the index. To make it simpler, SENSEX started in India in the year 1979 at 100 points. As the Indian economy and the capital markets developed the SENSEX rose along with it. Today it is at around 39000 points. So if you invested a certain amount in 1979 it would have multiplied in line with the current index level.
The prices of index fund schemes are nominal as compared to those of equity mutual funds. But how and why? Well that’s because as these funds aren’t actively managed the fund manager levies a very low charge as compared to active funds where a fund manager’s expertise and opinion is of utmost importance.
So if you are a ‘know-nothing’ investor who is completely new to the mutual fund industry and want to stay away from the hassles of researching about a well-performing mutual fund and just want to invest with minimum interference of fund managers, you should consider investing in index funds. Also if you are an investor who was to add a diversifying fund to their already existing financial portfolio, index funds are a good option to consider.