Different Returns from the Same Index Fund —How Costs Impacts Investment Returns

Same Index Fund, Different Returns —How Costs Reduce Investment Returns

In volatile markets, index funds can be part of an investor’s core portfolio because they provide the benefits of mutual funds, such as a diversified portfolio, greater transparency, and lower costs. They are essentially a type of mutual fund that tracks the returns of a financial market index.

Not just that, in India, passive investing is gaining popularity. Many investors are convinced that investing in an ETF or index fund is the most cost-effective way to build long-term wealth. The performance of large-cap index funds and ETFs over the last two years appears to have persuaded many investors in India of the invincibility of the passive strategy.

A Nifty 50 index fund, for instance, invests in stocks in the same proportion as its underlying index. One could conclude that the returns of all index funds underlying the same index should be the same. However, this is not the case in reality. Though the difference will not be significant, there is a substantial difference between similar index funds from various AMCs.

It does not have to be just the Nifty or Sensex; there can also be an international quotient and a bit of commodity. Gold has proven to be an excellent inflation cover, and it also performs well in bear markets. 

There is now a whole industry built around debt ETFs and debt index funds, which have a lot of market appeal. As a result, it is dependent on the investor. However, no matter how large, the core portfolio can be allocated to index funds.

Why do returns of index funds vary from their index and Other similar funds?

Entry and Exit Loads

These fees are levied upon investment and withdrawal from mutual funds. SEBI has eliminated entry loads for mutual funds. These fees are levied to deter investors from making premature withdrawals. 

They do not affect the fund’s return per se, but they affect the investor if he chooses to withdraw investments within the specified time frame. In general, funds charge an exit load of 1% of the amount withdrawn if it exceeds a certain percentage of the investment before a specific time.

Expense Ratio

Index funds are Passive Mutual Funds, which track a market index to maximize gains. The Fund Manager will not actively select which stocks to buy/sell and in what quantities. The corresponding fee will be lower because the fund manager will not be actively buying and selling. 

A fund manager’s fee is one of the most significant expenses for a mutual fund. Because this fee is low, the expense ratio will be meager. Investing in funds with a high AUM (Assets Under Management) is considered better because the expense ratio will be lower.

Invest accordingly

Index funds are advised for investors with a 7-year or longer investment horizon. These funds have been observed to have short-term fluctuations, which average over a more extended period. With a horizon of at least 7 years, you can probably earn 10-12 percent returns. You could align the long-term investment objectives with these investments and continue investing for as long as possible.

Final Thoughts

Index funds are nothing more than passive investments. They essentially remove the element of bias, or what we call an active management bias. They usually follow an index. Index funds provide many of the same benefits as mutual funds. 

You get a diversified portfolio, and you get good transparency. That’s because when you buy an index fund, you know exactly which stock comes in what quantity. 

There are various index providers – the National Stock Exchange, the Bombay Stock Exchange, CRISIL, and ICRA – all of which produce different types of funds. As a result, you can personalize your portfolio to some extent. There are numerous sector-specific indexes available.

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