When it comes to wealth creation, investment in the stock market sits right at the top. Your investments can reward you handsomely if you’re willing to stay invested for the long run. Nevertheless, there’s also an inherent risk that you must contend with. If the financial market performs poorly, you could lose a significant portion of your capital. To reduce exposure to market risk, one of the best strategies is to invest in a Nifty index fund. If you’re wondering what it is and how to do Nifty index investment, here’s some valuable information that can help clear things out for you.
What is a Nifty index fund?
A Nifty index fund is essentially a mutual fund wherein your money is invested in the stocks of the companies that feature in the Nifty index. When you invest in a Nifty index fund, you’re essentially investing in a mutual fund instead of a stock. The Nifty index fund is designed in such a way that the components of the fund match exactly with the companies in the Nifty 50 index. As the fund mirrors the Nifty 50 index, it follows the performance of the index irrespective of the market scenario.
With traditional mutual funds, the fund manager cherry-picks the stocks based on certain criteria. However, these mutual funds rarely provide you with broad market exposure or risk diversification. As a result, there is still the possibility of the Net Asset Value (NAV) going down, even when the financial markets are doing well, due to the underperformance of a few select companies in the fund portfolio.
This scenario is unlikely to happen when you invest in a Nifty index fund, as the underperformance of a few stocks ultimately gets balanced out by other outperforming stocks. A Nifty index fund drastically reduces the amount of risk that you’re exposed to and provides you with a degree of safety by giving you stable returns in the long run.
Advantages of investment in a Nifty index fund
Some of the advantages that a Nifty index fund has over individual stocks and more traditional mutual funds are explained below.
Lower risk
Since the stocks in the Nifty index fund are identical to that of the Nifty 50 index, you get to enjoy wider market exposure, thereby effectively diversifying your portfolio and reducing the risk involved. Since you are exposed to almost all the major industries and sectors in the market, your returns do not get affected greatly even if a particular sector performs poorly.
Stable Returns
The returns that you get may be higher with respect to individual stocks or industry specific stocks, but they may not be stable due to market fluctuations. However, that’s not the case when you invest in a Nifty index fund. The returns you obtain here are more stable and the potential for future growth is unlimited with these funds.
Elimination of bias
Whether you’re a fund manager or an individual investor, it is hard to put aside your emotions when picking stocks for investment. With a Nifty index fund, there is absolutely no emotional bias and the selection of the stock portfolio is completely objective, since this fund is designed to mirror the Nifty index.
How is Nifty Calculated?
According to the National Stock Exchange (NSE), the Nifty 50 is calculated using the free-float market capitalisation methodology. The formula that’s used to determine the value of the index is as follows.
| Nifty 50 Index Value = (Current Market Capitalisation ÷ Base Market Capitalisation) * 1,000 |
Here, the current market capitalisation refers to the weighted market capitalisation of all of the index’s constituents as of the date of the calculation. The base market capitalisation refers to the weighted market capitalisation of all of the index’s constituents as of the base date, which is November 03, 1995. And finally, the 1,000 refers to the base value of the Nifty 50 index.
How to invest in a Nifty index fund directly?
The following step-by-step procedure will give you a broad idea of how to invest in a Nifty index fund directly.
Step 1: Firstly, you require a trading and demat account to invest in a Nifty index fund. If you don’t already have one, you can open these accounts by visiting the website of your favorite stockbroker.
Step 2: Follow the procedure to open a trading and demat account as listed by your stockbroker. This would require you to fill in an online application form. Additionally, you may also be asked to upload scanned copies of Know Your Customer (KYC) documents such as a proof of identity, proof of residence, and income proof.
Step 3: Once your KYC verification is successful, your application for opening a trading and demat account will be processed by your stockbroker.
Step 4: Upon successful completion of the application process, a unique user ID and password will be shared with you. You can use this to login to your stockbroker’s trading platform.
Step 5: After logging into the trading platform, navigate to the mutual fund section and choose a Nifty index fund. Before selecting a Nifty index fund, it is a good idea to do a comprehensive analysis on its performance and track record. Also, ensure that you read through the entire scheme-related documents.
Step 6: Once you’ve chosen a Nifty index fund, you can either choose to start a Systematic Investment Plan (SIP) or buy units of the fund directly with a single, lump-sum payment.
Key Factors to Consider Before Investing in Nifty Index Funds
There are a few factors you need to account for before you invest in Nifty 50 index funds. Let’s look at some of the key considerations.
- Investment Objective
The primary objective of Nifty 50 index funds is to replicate the performance of the broad-market index. If you’re looking for index-beating returns, investing in Nifty 50 index funds may not be the right choice for you.
- Risk Profile
You need to consider your risk profile before investing in Nifty 50 funds. The Nifty 50 index is prone to volatility and short-term price fluctuations, making it a high-risk investment option ideal for risk-aggressive investors.
- Investment Horizon
Nifty 50 index funds are generally known to offer good returns in the long run. This makes them more suitable for long-term investors rather than those with short-term or medium-term horizons.
- Expense Ratio
Although all Nifty 50 index funds are passively managed, they don’t have the same expense ratios. Some funds charge higher fees than others. Therefore, always compare the expense ratios of different funds before investing.
- Tracking Error
Tracking error is a measure of how closely a Nifty 50 index fund follows or replicates the performance of the broad-market index. The lower the tracking error, the better the fund is.
Risks & Challenges of Investing in Nifty Index Funds
While investing in Nifty 50 index funds can be a simple and cost-effective way to gain exposure to the Indian stock market, you also need to be aware of the potential risks and challenges associated with investing in them. Here’s a quick overview of some of the key risks and challenges.
- Market Risk
Since the Nifty 50 is a representation of the overall Indian stock market, any economic downturns or other global events can have a huge impact on the index funds’ performance.
- Sectoral Risk
The Nifty 50 index consists of stocks from 14 different sectors. The underperformance of a few sectors can negatively impact the entire index, especially if the sectors are heavily weighted.
- Poor Market Timing
Not timing your Nifty 50 index investment properly can lead to your investment underperforming. For example, investing when the market is going through a bearish phase.
- Not Enough Diversification
The Nifty 50 index doesn’t represent all the sectors or industries in the Indian economic landscape. Emerging sectors like renewable energy and fintech are not adequately represented.
Conclusion
By following the steps above, you can invest in a Nifty index fund in no time. Investing in index funds can increase the likelihood of your funds performing well over the long term, thereby allowing you to realize your financial goals and needs in a much shorter span of time. Furthermore, since these funds are passively managed, you don’t have to spend a lot of your time monitoring your portfolio. Now that you have a better idea of how to do Nifty index investment, you only need to invest in them, sit back, and enjoy the returns.
FAQs
Can I invest in Nifty 50?
No. You cannot directly invest in the Nifty 50 index. However, you can invest in Nifty index funds, which are basically mutual funds that have the same constituents as that of the index. The primary objective of these Nifty index funds is to replicate the performance of the broad-market index.
