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Business News/ Money / Personal Finance/  Why should you rebalance your portfolios using index funds?
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Why should you rebalance your portfolios using index funds?

Index investing is essential to portfolio diversification as it helps mitigate risks while ensuring market-linked returns.

Investing in index funds for portfolio diversification. (Pixabay)Premium
Investing in index funds for portfolio diversification. (Pixabay)

The markets are bleeding, thus, prompting many to rejig their portfolios. Add inflation to the current chaos, and you will realize that the risk to your portfolio is higher than that is being perceived. Investors inclined to park their money in various financial instruments are now opting to invest in debt, gold and real estate. The fear of seeing their portfolios in red for a prolonged period has now sent many in a tizzy with some of them even seeking guidance from personal finance experts about the available passive fund investments. While it may be okay to place bets on focused or thematic funds as active investments, you must include an index fund too for portfolio rebalancing through passive investments.

Passive investments include parking a part of your money in index funds. Apart from investing in broad market indices, investors can think of investing in sectoral indices including healthcare, banking, technology and so on.

Both new and seasoned investors can benefit from investing in index funds. These passive funds must be bought apart from the active funds to benefit from market-linked returns, low tracking error, diversification and transparency regarding the fund’s composition. The best part of investing in these funds is that you can put your money either in a lump sum or through systematic investment plans (SIPs).

Investing the passive way

Not many investors are aware of how investing simply by replicating the index can help them to gain returns through passive investing. What helps investors is that there is no chance of fund manager biases affecting the returns from these funds. Investments in stocks are in the proportion at which they are traded on that particular index. The two most popular ways of parking money in indices are investing in indices (equity and debt) and exchange-traded funds (ETFs). The investments then replicate the index at which the stocks are moving, i.e., bought and sold. Though you can trade in ETFs during market hours, you can buy an index fund only at the price set at the end of the trading day.

Benefits of investing in passive funds

Passive fund investments have their benefits including continued stable returns, thus, explaining the need to include them in your portfolio. The other advantages include:

Diversification

Diversifying the portfolio is a benefit that we dare not agree considering how tumultuous the stock market movement can be. Instead of investing directly in stocks, you may park money in the underlying indices like the Equity index fund like Nifty 100, Nifty Smallcap 50 or debt index fund like AAA Bond, you automatically gain access to some of the good stocks that help earn returns in the long run while lowering the inherent risk associated with a particular stock or sector.

Low-tracking error

True that index funds replicate the index movement. Despite this, returns from index funds differ. If you are not sure which index fund to invest in, you must look at the tracking error of each fund. This will help you assess to what extent the fund’s returns have deviated from that of the benchmark index.

Transparency

You are well aware of the constituent stocks of your index fund, thus, allowing for transparency regarding the investments you have made. With a better understanding of where your money is being invested, you always have a better opportunity to rebalance your portfolio by then investing in stocks that may not be included in that particular index.

Risk mitigation

You want to take minimum risk while wanting to benefit from the equities in your portfolio. The returns from your index fund will ensure that you get just that without going through the hassles of portfolio composition, stock rebalancing and other measures that require their detailed evaluation. It is only when you stay invested for a prolonged period, you will realize how the market’s risks are mitigated amidst easing out of the volatility component.

From financial dreams to reality: Follow these steps
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From financial dreams to reality: Follow these steps

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Published: 17 Jun 2022, 04:08 PM IST
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