Things to look at before buying an Index fund

index fund

I shared it with new investors who want to know about why they have to invest? and where to park their first investment? . At the end of the posts, I said to invest in an Index fund alone, instead of an active fund for chasing extra returns ( which you’ll fail).

Today, let me share the things you’ve to look at before buying an index fund. Check the above posts if not.

Let’s get started.

 

Who should choose index funds

If you don’t know how to do an analysis on your investment or don’t have time for that. You people can choose an index fund. So, you’re betting on the index (that is the market itself).

Simple, index investing is passive investing, and you can sleep peacefully by knowing you’ve made the right investment.

I recommend every retail investor to go for index investing.

 

Thinks to look at before buying an Index fund

  1. Net Asset Value (NAV) Don’t care about NAV of the fund.

    Like stocks have share prices, mutual funds have NAV units but it’s not the same. Stock prices change due to demand and supply (traded) but the NAV of a fund can’t be traded like a stock, its value changes only once at the end of the day.

    Don’t look at the NAV of the fund when buying. It makes no difference, look at the below snap for the reason.

    index fund
    Comparison of NAV between two funds
  2. Asser Under Management   AUM is the total money the fund holds. One of the key metrics to choose any fund is by AUM. AUM of the fund should be higher (higher the better, at least more than 1000cr).

    For e.g. -If you have invested in L&T Nifty 50 Index Fund has an AUM of 94cr as of today, and if an investor has invested 10 cr and withdraws that 10cr > then the NAV of the fund falls > then your investment will also goanna affect.

    In the case of a fund with more than 1000cr AUM, 10cr withdrawal is less than 1% of their AUM.

  3. Asset Management Companies (AMC) – Choose a well-known AMC for your index fund. Don’t go for any new AMC which started yesterday. Example: recent buzz on Navi AMC.

  4. Expense Ratio – The main reason for choosing an index fund is the expense ratio because active funds require higher expenses for managing their fund. For an index fund, they don’t need much, so it’ll be much lower than that.

    Comparing these active and index fund expenses, you may feel the difference is minute, but in a long-term perspective it can cost you lakhs.

    You’ve to look for a low expense ratio but don’t choose a fund because it has a low expense ratio… Expense ratio changes from time to time…AMCs lower their expense to the ground sometimes especially new funds, which is just an attraction or inviting you to invest there.

    For e.g., Navi mutual fund has an expense of 0.06%, which is the lowest I know- it is a new index fund, and they have a low expense ratio to attract investors.

    Adding a point here, if Navis AUM value increases … Then Navi will also increase its expense ratio equal to or more than UTI, HDFC, and ICICI index funds expense ratio. Initially, they don’t get much expense for small AUM. ( I don’t have any personal grudge against Navi )

  5. Similar index funds on different AMCs  – There is no need to choose multiple funds in the same index (having both UTI Nifty 50 and HDFC Nifty 50 funds ) because all the funds are going to invest in the same 50 companies so there won’t be many differences in performance…

    So, invest in only one index fund, you don’t need the same index funds on different AMCs, it makes no sense.

    If you want, you can invest in other types of index funds (e.g., nifty next 50/ nifty 100), this is different.

  6. Don’t look at the star rating for your index fund  – Don’t look at rating from valueresearch or morningstar.This is passive investing and of course, their computerized metrics won’t apply to index investing and ratings will be low, you don’t have to worry about that .

  7. Direct vs Regular  – Always buy direct plans .

    Direct means you buy directly from the mutual fund company, whereas regular means there is an intermediate between you and the fund in the form of a broker/advisor.

    Brokers won’t charge you directly. The expense ratio of the regular fund will be a little bit higher than its direct fund. (AMC pays to broker)

    Check the difference in expenses for the same UTI index fund here, direct and regular (under basic details).

  8. Tracking error – Due to buying and selling of stocks, the fund return sometime will be higher or lower when compared to its underlying index. But it should not be like that, it should travel in line with its index.

    Simple, tracking error = funds return – index return, if the answer is zero or anywhere near to zero then it is a good fund to sign up…

    I bought a tracking error sheet from freefincal when buying my index fund.

  9. Don’t choose any other indices than N50 and NN50 – Don’t go for other funds which have other indices like midcap, small-cap, nifty 500, etc. because there will be high tracking error and high impact costs (the additional cost when buying and selling in huge quantities) on these funds.

    I would say one Nifty 50 and one Nifty Next 50 index fund is enough for a normal investor like us… nothing is needed than these two.

  10. Don’t go for an index ETF  – Index funds have a lower expense ratio, but index ETFs are much lower in expense than that, don’t buy ETFs because of this one reason.

    ETFs have both NAV and share price. And the returns you get from ETFs are by their price not by their NAV.

    What if mutual funds NAV are traded with a price that is called ETF, it behaves like a stock. There will be a minor difference between its NAV and its price due to demand and supply.

    ETFs are good for trading not for long-term investment.

     

Why we need an index?

Buffett’s Million $ bet on Index fund

In 2008, Warren Buffett made a bet for 1 million $ with Ted Seide – the bet is by the next 10 years Buffett’s chosen Vanguard S&P 500 index fund (like our nifty index) will beat Ted’s 5 baskets of hedge funds.

Ted lost and Buffett won in 2017. The reason is that the high expense ratio of active funds cannot beat the low expense ratio of index funds over a long-term period.

Buffett’s index fund averaged a 7.1% average return, vs. 2.2% for the hedge fund basket. (The return percentage is for the US, as their market is very stable compared to ours)

Buffett may be an active investor himself, but from his million-dollar bet, he is clear that active investing won’t be suitable for all investors.

 

The fund which I selected

The fund I am investing in is UTI Nifty 50 index fund and UTI Nifty Next 50 index funds. These are the two index funds that passed all my criteria like AUM, tracking error, expense ratio, etc. when I selected them two years before. It may vary now, so it’s not a recommendation.

And I used ET money app for MF investing and they have only direct plans.

Hope you’ll look at these things before buying the first index fund. From this post  you might have found a few of your mistakes in your index investing, correct them now at least.

 

Have a wealthy future ahead, bye.
Peranesh xx 

 

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My favorites of the week

1. “I’ve been banging away at this thing for 30 years. I think the simple math is, some projects work and some don’t. There’s no reason to belabor either one. Just get on to the next.”

          — Brad Pitt accepting a Screen Actors Guild Award

Source : The Psychology of Money by Morgan Housel 

2. BNPL apps achieved an insane growth rate of 569% in 2020 and 637% in 2021.

Ganesh prasad clearly explains the business of Buy Now Pay Later (BNPL) like Slice, Lazypay, Simpl etc.  and their masterminds behind it from his channel “Think School”.

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