Index Funds: Debunking 5 Common Myths

Index Funds: Debunking 5 Common Myths

Index funds, mirroring market indexes like the Sensex or Nifty, offer a compelling investment option. However, several misconceptions surround them. Let’s debunk five common myths:

Myth 1: Index Funds Are Completely Passive

While index funds promote passive investing, choosing a specific index fund is an active decision. Additionally, fund managers actively manage scheme liquidity (within a 5% buffer allowed by SEBI) to meet redemption needs and mitigate liquidity risk.

Myth 2: You Need a Demat Account for Index Funds

Unlike stocks requiring a demat account, you can invest in index funds through your mutual fund folio. Since index funds hold exchange-traded securities, demat accounts aren’t mandatory.

Myth 3: All Index Funds Tracking the Same Index Deliver Identical Returns

While similar portfolio compositions exist in index funds tracking the same index, returns might differ slightly. Tracking error (delays in replicating index changes) and expense ratios can cause these variations.

Myth 4: Index Funds Are Risk-Free

Index funds, like any mutual fund, carry market risks. While they mitigate unsystematic risk (specific to companies), they remain exposed to systematic risk (broader market fluctuations). However, the market’s long-term positive trend suggests potential for growth.

Myth 5: Index Funds Are Taxed Like Regular Equity Funds

Most index funds are taxed as equity funds, enjoying special long-term and short-term capital gain rates. However, index funds tracking international equities might be taxed differently if they invest less than 65% in domestic companies (the threshold for equity fund taxation).

By understanding these myths, you can make informed investment decisions and potentially benefit from including index funds in your portfolio.