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How to choose an Index Fund?

Nikhil Desai
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Index Funds and Index investing

Investing in a basket of stocks or other securities which forms part of a benchmark index and in the same proportion as the benchmark is called index investing. And an index fund is a type of mutual fund, which constructs a portfolio to reflect/match or track the market indices. As these funds follow the composition of the index these funds are passive investing funds. These funds provide broad market exposure, lower operating expenses and lower portfolio turnover to the investors.

How to determine best index fund?

While choosing an index fund, investors must be wise and well known to the market. Even if these are passively managed funds, the research before investment is necessary. The primary aspect to look for in an index fund is expense ratio, lower expense ratio gives the higher return visibility for investor. So the expense ratio must be taken into consideration while investing.

The second and the most important aspect of analysing index funds is tracking error; lower the tracking error effects the fund portfolio's performance. Tracking error is a statistical parameter which evaluates an index fund's effectiveness in replicating or matching the performance of the benchmark index. Expense ratios for mutual funds are publicly shared and easily available, however tracking error isn't something that is publicly displayed. Therefore, while surfing for the best index funds, investor should start by looking for the lowest expense ratios as a primary filter among index funds. And then should look at the actual past performance of each fund and compare it directly with its respective benchmark.

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