Trading options for everyone

Simpler option Keep “track” of a stock index

Simpler option Keep “track” of a stock index   | Photo Credit: KHAM

If you are not up for trading on individual stocks, you could give index mutual fund and exchange traded fund a try

In one of the earlier columns, we have seen how index funds can be used to get exposure to the stock market in a low cost way. We also learnt that by using direct mutual fund schemes, we can bring down the cost of the funds even further. In today’s column, we will revisit the concept of index funds and direct schemes of mutual funds. After that, we will also learn about a new financial product called the ETF or the exchange traded fund.

Simple alternates

Do you recall what an index mutual fund is? A mutual fund is a collective investment scheme which enables small investors to pool their assets and build a portfolio. Say you have ₹10,000. You want to start building a diversified portfolio. You check out the market and you find that you can buy around 15 or so blue chip stocks after which you run out of money. You were looking to build a portfolio of around 25 stocks. How do you solve this? Enter the mutual fund. By collecting ₹10,000 from 1,000 people like you, the mutual fund can build a large, well diversified portfolio, out of which you get a share (1/1,000). This is a clever idea.

Mutual funds have fund managers who actively select stocks for their portfolio with the aim of delivering better returns than the bench mark indices. Often, they fail in this endeavour as “beating” the market consistently is not easy. So was born the index fund, which simply “tracks” the performance of a stock index like Nifty or Sensex. In this case, the fund manger does not have to do anything clever and he also does not need an army of highly paid analysts. Therefore, the costs associated with manufacturing and distributing the index funds is lower. And all this savings come to you — the investor. You can do even better by cutting out the middle men and directly buying the index fund from mutual fund companies via the “direct plan”. The cost savings may look marginal — a percentage or so here and there, but remember, these are costs that you save every year. Over a period of several years, such cost-efficient investment products deliver great returns to investors.

ETF is another interesting investment product. This product is listed on stock exchanges like the NSE and you can buy and sell them the way you would buy and sell a stock. That is pretty neat, isn’t it? You can get the diversified exposure of a basket of stocks just by executing a single transaction without the need of an advisor. Cheap electronic trading platforms like Zerodha can be used to buy and sell ETFs. The financial outcome of an ETF is not very different from that of an index fund. In fact, most ETFs are manufactured by asset management companies. Yet, there are interesting differences between the ETF and index funds. In our next column, we will see what these differences are. Meanwhile, if you are really curious, you can do your own research and email me the top ETFs in the Indian market.

The writer is an alumnus of IIM Bangalore and co-founder, Money Wizards.

Why you should pay for quality journalism - Click to know more

Related Topics
Recommended for you
This article is closed for comments.
Please Email the Editor

Printable version | Apr 8, 2020 11:40:18 AM |

Next Story