Do you want to track the stock market passively? Are you a beginner in stocks looking for long-term investment? You could invest in index funds which is a good starting point for novice investors in stocks. It is a passive mutual fund that mimics the portfolio of stock market indices such as the Nifty 50 or the BSE Sensex. However, should you invest in Sensex or Nifty Index Funds?
What are Index Funds?
Index funds invest in stocks that constitute a particular stock market index in the same proportion. It mimics the index so that you get similar returns as compared to the index it tracks.
For example, an index fund may track the Nifty 50, representing the weighted average of 50 of the most prominent Indian Companies listed on the National Stock Exchange of India or NSE.
Similarly, the index fund may track the BSE Sensex representing the weighted average of 30 well-established companies listed on the Bombay Stock Exchange or BSE.
Should you invest in Sensex or Nifty index funds?
You could invest in index funds tracking either the Sensex or the Nifty 50 as both indices have similar historical returns. For instance, both stock market indices represent the weighted average of the biggest Indian companies where the top 20 companies command the most weight. Moreover, many of the stocks that comprise the Nifty 50 and the BSE Sensex overlap.
Many investors believe investing in Nifty index funds is better than Sensex index funds. However, financial experts advise you to invest in either Nifty or Sensex index funds as both are equally good investments. For instance, even though there are minor differences in the daily movements of the stock market indices, they yield similar returns over the long term.
You could invest in either index funds that track the Sensex or the Nifty 50 if you are a long term investor. For example, the BSE Sensex has a higher concentration than the Nifty 50 as it comprises the top 30 Indian companies. It helps to understand that Sensex may offer slightly higher returns during a narrow rally in the stock market. However, the Nifty 50 offers better returns during a broad-based rally that includes most Nifty stocks.
The stock market indices may outperform each other during some market phases. However, over the long term, say 10 years, both stock market indices offer similar returns. Should you invest in both Sensex and Nifty index funds? You may invest in either index fund as you won’t enjoy additional diversification because of the overlapping portfolios. It helps to pick other stock market indices outside the top-50 stocks, such as the Nifty Next 50, if you want more diversification for your portfolio.
How to pick the right index fund?
You must select an index fund that has higher assets under management (AUM). It can handle the sudden redemption pressure of major investors during a liquidity crunch. You must pick an index fund with a lower expense ratio. It is the cost of managing the fund, and a lower expense ratio increases your overall return over time.
You must check the index fund’s tracking error, which is the difference in returns between the index fund and its target stock market index. It may be due to the cash balance of the index fund and mutual fund expenses. You must invest in an index fund with a lower tracking error to minimise deviation from the benchmark index.
You can invest in either Sensex or Nifty index funds to attain your financial goals over the long term. It helps to check the expense ratio and track errors before investing in index funds. In a nutshell, as there is a huge overlap between the portfolio of Nifty 50 and the Sensex, you get similar returns over the long term.
For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in
I write to make complicated financial topics, simple. Writing is my passion and I believe if you find the right words, it’s simple.
