How to Invest in US Index Funds From India: A Beginner’s Guide | Stockal (2024)

Have you been wondering how to invest in US index funds from India? According to a trade organization called the Investment Company Institute, passive assets make up 40% of the total net assets that are managed by funds in America. Examining the phenomenon is necessary. The soundness of the fundamental concept underlying index funds—that conventional investment funds are, for the most part, a lousy idea—has contributed to their growth. As a result, the vast majority consistently underperform the market over time.

Huge management payments made by investors in these projects, which are typically in the range of 1-2% annually (and even more for swanky hedge funds), translate into enormous compensation for stockpickers. In comparison, index funds charge practically nothing (0.04% for a major stock fund) and closely track the benchmark of their choice.

How Does an Index Fund Work?

If you want to find out how to invest in US index funds from India, let us understand how they work first. Index fund investing has long been regarded as one of the best financial decisions you can make. Index funds are reasonably priced, provide for diversification, and typically produce enticing returns over time. In the past, index funds have often outperformed other fund types that are actively managed by renowned investment houses. A collection of assets known as an index fund, which can be a form of an exchange-traded fund or mutual fund, tracks the performance of a market index like the S&P 500. A fund that mimics an index will typically hold the same investments in a similar distribution. The index itself is typically concentrated on a particular industry, region, or stock market.

Advantages of Index Funds

Index funds allow for extensive diversification, are inexpensive, and offer competitive returns. Find out more about these main advantages:

• Extensive Diversification

Index funds’ most apparent benefit is that they rapidly diversify the portfolio, lowering the likelihood of losing all or majority of your investments. For example, consider an index fund which follows the S&P 500. There would be 500 different equities in this index fund. Although the performance of every one of these 500 stocks changes over time, buying a fund that holds them all aligns the performance of your portfolio with the index. Investing in only one index fund and spreading your money among so many different companies may ensure that the worth of your portfolio is not too associated with the performance of any of the index’s listed companies.

• Low Costs

Index funds may have cheaper expenses than other kinds of investment funds, including taxes and management fees, is another significant advantage of investing in them. The annual management fee each fund manager receives is the first expense to consider. After that, the fund’s expense ratio determines the fee amount, which changes based on the worth of your assets. For instance, if you invest $1,000 in a mutual fund with an expense ratio of 1%, the management charge would be $10. Expense ratios for actively managed mutual funds typically fall between 1% and 2%. The majority of that charge funds the buy-and-sell choices that portfolio managers make to outperform the broader market.

In contrast, index funds are handled passively. The holdings of the index fund hardly ever change because they merely follow an index by purchasing and holding each of the stocks in that index. Because the management of the index fund has minimal work to do, the expense ratio is relatively low. Some index funds could have expense ratios as low as 0%, whereas the normal range for expense ratios for index funds is between 0.05% and 0.07%. For example, you would only be required to pay $0.50 in management fees if you held $1,000 in an index fund with an expense ratio of 0.05%.

• Turnover Ratio is Lower

The turnover ratio calculates the percentage of holdings that are changed in a fund in a given year. For instance, a fund’s turnover ratio would be 10% if 10 of its 100 stocks were exchanged this year. Naturally, the turnover ratio of index funds is smaller than that of actively managed funds. For example, in contrast to certain actively managed mutual funds, which have turnover ratios of 20% or greater, index funds typically have turnover ratios of 1% to 2% annually.

• Capital Gains Have Lower Taxes

The difference between the original acquisition price and the ultimate sale price of a stock sold by a fund for a profit is regarded as a capital gain. As a result, investors in funds with more excellent turnover ratios must pay more taxes since these funds generate capital gains more frequently. However, the low turnover ratios of index funds make this less of an issue. Since fund managers don’t frequently sell stocks, shareholders don’t frequently receive capital gains.

• Attractive Returns

According to Standard & Poor’s data, only around 23% of actively managed mutual funds beat the S&P 500 over a five-year period. The market is outperformed and underperformed by certain companies, but in general, the value of the stock market as a whole rises over time. Index funds are an excellent value for any investor since they often produce good returns at cheap costs.

Past Performance and Portfolio Diversification

While you figure out how to invest in US index funds from India, it could be helpful if you look at their past performance. Index funds’ sole objective is, by definition, to follow their benchmark indices prior to fees and expenses. Therefore, over time, actively managed funds could underperform market indices. For example, the average active equity fund manager underperformed the larger market, as measured by the Schwab 1000 Index, throughout the 5- and 10-year periods that are ending June 30, 2022.

A fundamental principle of investing is the distribution of risk. Portfolio diversification can be achieved through mutual, exchange-traded, and index funds. Some index funds offer exposure to tens of thousands of stocks, or nearly the whole universe of investable equities. The risks of a portfolio get spread out by diversification. The likelihood that one stock will significantly reduce a portfolio’s value decreases as the number of stocks in the portfolio increases.

Selecting the Best Index Funds and Building a Portfolio

• Choose Index Funds that Come With the Lowest Expense Ratios

Most index funds and ETFs impose an expense ratio, which is a yearly fee. The fund’s operating costs are covered by this modest fee. Since there isn’t a line item on your routine fund statements that reveals how much the fees cost you, it’s not precisely apparent that you’re paying an expense ratio. Instead, a portion of the fund’s assets is subtracted automatically from your returns.

When running an index fund, the fund manager essentially just copies the index’s constituents. Thus, the expense ratio of passively managed funds is typically lower than that of actively managed funds. The cost of an index fund becomes a key differentiator because all index funds that follow the same index will have the same portfolio. The fund’s returns are directly impacted by the cost. An index fund that tracks the same index but has a lower expense ratio will probably produce higher returns.

• Choose Index Funds that Come With Lower Tracking Error

Whenever the fund cannot keep up with the changes in the index, a tracking error occurs. For example, let’s say an open-end fund that tracks the S&P 500 increases by 90 basis points while the S&P 500 rises by 1%. A tracking mistake would arise from the discrepancy. To put it another way, it is a gauge of how well the fund can follow or mimic the performance of the index. An index fund’s goal is to replicate the performance of the index, hence the lesser the variance, the better.

Index Funds vs ETFs

Index funds and ETFs have the same investment goal but attain it in various ways. The following are the main variations between ETFs and index funds:

• ETFs trade continuously, while index funds only trade once at the end of the day.
• If purchased commission-free, ETFs are frequently less expensive than index funds.
• Although some fund providers, including Fidelity Investments, are lowering the minimum investments on mutual funds, index funds often have more significant minimum investments than ETFs.
• While ETFs must be purchased by share-like stocks, index funds can be purchased in dollar increments.
• Mutual funds are less tax-efficient than ETFs.

How to Invest in US Index Funds From India?

Looking back at the question of how to invest in US index funds from India, here’s how. Index funds might be an excellent addition to your portfolio if you want to allow your money to grow gradually over time, especially if you’re saving for retirement. Index funds follow a variety of indices. For instance, the S&P 500 is among the most well-known indices since it tracks 500 large, well-known U.S. corporations that span a variety of industries. It’s time to look at the particular index funds you invest in once you’ve decided on the index you want to follow. There are various things to think about when researching index funds.

Through Stockal, which offers a wide range of solutions to meet the demands of investors, it is simple to gain exposure to US index funds.