Jul 17, 2021
Warren Buffett, the world’s most famous investor, has frequently touted the benefits of investing in low-cost index funds.
In fact, he’s instructed the trustee of his estate to invest in index funds.
You might ask, why?
Why would the master of value investing suggest investing in index funds and not individual stocks?
You see, patience, discipline, and risk aversion are the essential ingredients for success in picking stocks.
This means that individual stock picking is not for everybody.
In fact, Buffet says most average, long-term investors would benefit from a much simpler strategy – investing in low-cost index funds.
What are index funds?
Index funds may sound intimidating, but they’re just a basket of stocks that represent a broad market.
As the name suggests, these mutual funds typically invest in stocks that are a part of an index such as Nifty 50, Sensex, etc.
If a fund is benchmarked to the BSE Sensex, then its performance over a period of time will match with the performance of Sensex.
This results in automatic diversification, which reduces your overall risk.
There is also no market timing or individual stock picking involved. The fund simply tracks the performance of the index.
What is the expense ratio and why is it relevant?
Since investing in an index is more passive than active, the expense ratio of a fund is an important criterion for fund selection.
The total expense ratio (TER) is the ratio of the total cost of running and managing the fund to its average assets under management (AUM).
Total Expense Ratio = Total Costs/Average Assets Under Management
Fund expenses can make a significant difference in an investor’s profit.
If a fund realises an overall annual return of 5% but charges an expense ratio of 2%, then 40% of the fund’s return is spent on fees.
That’s why investors should always compare expenses when researching funds. This is often far lower for index funds compared to active funds.
The Indian market regulator allows fund houses to charge a TER of up to 1% for index funds.
Now that you have a brief understanding of the above, have a look at the top 5 index funds in India with the lowest expense ratios.
#1 Navi Nifty 50 Index Fund
Navi Nifty 50 Index Fund is the latest entrant in the category of index funds. The fund was launched by a relatively new fund house Navi Mutual Fund.
It’s owned by the co-founder of Flipkart, Sachin Bansal.
The fund tracks the Nifty 50. It is the only scheme that has the lowest expense ratio of 0.06%.
There is no historical data available for this fund as the fund recently opened for subscription on 3 July 2021.
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#2 Motilal Oswal Nifty 50 Index Fund
The Motilal Oswal Nifty 50 Index fund has an expense ratio of 0.1%. The fund was launched in August 2019 and is benchmarked against the Nifty 50 Index.
The average AUM of the scheme was Rs 763 m at the end of June 2021. The scheme has generated returns of 50.5% in the last year.
#3 Nippon India Index Fund – Sensex Plan
The Nippon India Index Fund – Sensex Plan has an expense ratio of 0.15%.
The fund was launched in September 2010 and tracks the performance of S&P BSE Sensex. The AUM of the scheme stands at Rs 1.5 bn at the end of June 2021.
The scheme has given returns of 47.7% in one year, 14% in three years and 14.6% in five years.
#4 Axis Nifty 100 Index Fund
The Axis Nifty 100 Index Fund also has an expense ratio of 0.15%. This fund tracks the Nifty 100 Index.
The fund was launched in October 2019 and has an AUM of Rs 4.5 bn as of June 2021. It has offered returns of 50.1%in the last year.
#5 IDFC Nifty Fund
IDFC Nifty Fund is one of the oldest schemes on this list. The scheme has an expense ratio of 0.16%.
The fund mirrors the performance of the Nifty 50. Since its launch in April 2010, the AUM of the fund has grown significantly.
The AUM of the scheme was Rs 3.3 m at the end of June 2021. The scheme has generated returns of 50.8% in one year, 14.1% in three years, and 14.2% in five years.
Will investing in index funds get cheaper?
The cost of investing in index funds is unlikely to decline further as such low costs are unviable.
Index funds need to charge at least 0.1 – 0.15% to cover their costs for managing the scheme, such as sales and marketing, administrative expenses, transaction costs, and investment management fees.
While index funds such as the Navi Nifty 50 Index Fund have reduced their TER to 0.06% to attract assets, few index schemes such as Tata MF, UTI MF and HDFC MF have increased the TER for their direct plans.
HDFC Index Fund- Nifty 50 Plan had a TER of 0.1% which later increased to 0.2% in its direct plan. Tata Index Fund-Nifty had a TER of 0.05% which was hiked to 0.19% at the end of May 2021.
Is cheaper always better?
Investing in index mutual funds and exchange traded funds (ETFs) can be an excellent low-cost strategy for a part of your investment portfolio.
However, like any other investment strategy, investing in index funds requires that you understand what you are investing in.
Not all index products are the same and investors need to look beyond the “index fund” label to ensure they are truly investing in a product that fits with their investing strategy.
Moreover, a fund with a lower expense ratio may not necessarily be the best one. One must also keep in mind the tracking error (deviation in returns from the benchmark), fund size, and track record of the scheme.
While a high tracking error can occur due to different reasons, it’s mostly when a fund is not closely tracking the underlying index and when it is under redemption pressure.
One must also prefer schemes in existence for at least three years. This will allow you to check the performance of the fund over different periods and allow you to make a well informed decision.
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Ayesha Shetty is a financial writer with the StockSelect team at Equitymaster. An engineer by qualification, she uses her analytical skills to decode the latest developments in financial markets. This reflects in her well-researched and insightful articles. When she is not busy separating financial fact from fiction, she can be found reading about new trends in technology and international politics.