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What’s an Index Fund ?

Before we dive deep into the world of Index Funds and why it’s one of the best investment strategies for any sane Investor. Let us first understand the Indices available in Indian Market today.

There are 2 Exchanges available in Indian Stock Market as of 2018. Bombay Stock Exchange ( BSE ) and National Stock Exchange ( NSE ) .

BSE	NSE
Established in 1875 , known as SENSEX	Established in 1992, known as NIFTY
Asia’s first stock exchange.	—
World’s 10th largest exchange	Worlds 11th largest exchange
Overall market cap of 2.3 trillion USD as of April 2018.	Overall market cap of 2.27 trillion USD as of April 2018
Not open to all and needs trading membership	NSE ensured that anyone who was qualified, experienced and met minimum financial requirements was allowed to trade.
Contains 30 Top companies of BSE	Contains 50 top companies of NSE , National Fifty , hence the name Nifty

The stocks that are traded at the BSE and NSE account for only around 4% of the Indian economy unlike in countries like the US, where most of the GDP comes from huge corporates. This is the reason some believe that the Economy of India is not completely defined by The Stock Market. Lately the GDP of India is very closely being mapped to Nifty 50 , due to shere fact of companies like Reliance , TATA etc. being part of the Stock Market. 

Barely 1.3% of India’s population invests in the stock market, as compared to 27% in USA and 10% in China as of 2018.

More on indices…

A stock index or stock market index is a measurement of a section of the stock market. It is computed from the prices of selected stocks (typically a weighted average). It is a tool used by investors and financial managers to describe the market, and to compare the return on specific investments. – Source : Wikipedia

BSE's index is called the SENSEX and NSE's Index is called the NIFTY.

Why is Nifty a better choice ?

• NSE needs no membership to participate and is open to all
• Fully automated electronic set up for national level trading
• Nifty has a broader set of companies compared to Sensex and hence more diversified.
• More stringent protocols for a company to get listed compared to BSE. As a result, a lot of bogus companies are kept at bay.

Nifty = NSE + top fifty

Nifty represents the weighted average of 50 Indian company stocks in 12 sectors. At any given time the investor is assured that Nifty will have only the best companies based on their performance and market capitalisation.

Nifty is also called the market benchmark

Index Rebalancing:

Nifty Index is re-balanced on semi-annual basis. The cut-off date is January 31 and July 31 of each year, i.e. For semi-annual review of indices, average data for six months ending the cut-off date is considered. Four weeks prior notice is given to market from the date of change.

In other words Rebalancing makes sure that only the best companies are part of the Index based on their Market Capital and growth. Hence investing in an Index Fund makes sure that one is always invested in top 50 companies in India.

Nifty is maintained by SEBI. Nifty is also used to see how India is doing in terms of growth. Someone with no investment in Index might feel when it goes down he/she is not affected in any way. That’s not entirely true and in fact it showcases the buying power of a common man as it is closely tied to the GDP of a country.

Investing both in Nifty and Sensex is a bad idea as 30 companies in Sensex are a subset of Nifty

Tracking Error

Tracking error is the difference between a portfolio’s returns and the benchmark or index it was meant to mimic or beat. Tracking error is sometimes called active risk. 

12 sectors from which companies are selected

The sectors are well diversified and as an investor you can be rest assured to buy a piece of business in every sector in India. As of 2019…

When you buy a share, understand that you are buying part of the business and trust that it will make you rich on a longer run. Never see it as a vehicle for Short-Term gains. Only invest money that you will not need for say the next 15-20 years. There is no fast lane to make money in the Stock Market as it’s a Zero Sum Game.First 10 companies part of Nifty as of November 2018

Q: What do you mean by Zero Sum Game ? A: A Stocks only purpose in life is to be bought or sold. One can do so, when there is a bigger fool trying to buy when someone is willing to sell. Only time can tell if Buyer or Seller of the stock was the smarter of the lost. One has to lose money for the other to gain , hence it’s called a Zero sum game. This is only true in short-term.

Only the top 50 best companies in the selected 12 sectors are listed at any given time in Nifty. When a company performs, it automatically drops out of Nifty and the next contender enters the list. 

A company's share price may tank by 10-20% when it drops out of the Nifty or Sensex. This is a litmus test for a company to force them to get their act together !

Q: Why is Nifty a litmus test for companies ? A: Like I said earlier in order to get into Nifty 50 , one has to be among the top best companies in India. As soon as a company becomes part of Nifty, it is considered a worthy company to invest in , as its balance sheets and revenue have been good lately. Please search on the internet about litmus paper , if you don’t come from a chemistry background.

If one invests in Nifty, 50% of the amount goes into the top 10 companies in the list and the remaining 50% goes into the next 40 companies. All this happens without having to worry about the distribution of capital by the investor.

Example : If you were to invest 1000 INR in the Nifty 50 Index Fund today , 500 INR would go into the above 10 companies based on the weightage. That is , 10.54% of 500 = 52.7 INR would be invested in HDFC Bank Ltd.We will understand why Index Fund is the best choice for any long term investor in the coming chapters !!

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