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Index Funds vs Stocks: Which One is Better?

IndianMoney.com Research Team | Posted On Friday, November 01,2019, 02:47 PM

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Index Funds vs Stocks: Which One is Better?

 

 

Index Funds vs. Stocks: Which Investment Option is Better?

If you have sound knowledge about the financial markets, have high-risk tolerance and can devise good investing strategies then investing in stocks is the right option for you.

Index funds are ideal for investors who are risk-averse and expect predictable returns from their investments.

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What are Index Funds?

The index fund is a type of mutual fund that creates your portfolio based on the composition of the standard market index like Sensex or Nifty 50. These funds not only invest in stocks that constitute the benchmark index but also invest in amounts in which the index is represented. The idea behind index funds is to replicate the index performance and generate returns at a minimal cost.

What are Stocks?

A stock refers to a kind of investment that represents the ownership share of a company. When you purchase the shares of a company you become a part-owner of the company.  This means you can grow with the company and get a proportional share of its profits or losses depending on the success of the business venture. 

See Also: Index Funds In India - Best Index Funds for 2019

Let’s try to understand which investment option is best suited for you:

Investing in Index Funds:

Investment in index funds is mainly suited for investors who want to invest their money for the long-term. If you take a look into the past performance of the indexes, you will realise that they have performed consistently well in the long-run despite some instances of short-term volatility.

Most of the index funds in India track the benchmark indices like Nifty and Sensex. Nifty 50 is one such index that consists of the index of 50 largest stocks that follows the Nifty 50 stocks. Another index is the Nifty 20 that tracks relatively undervalued stocks which are measured by the parameters like price to ratio earnings, price to book ratio, dividend yield and return on capital employed.

Investing in index funds is simpler than investing in stocks. Investors are attracted to these funds because they do not need to spend more than a few hours every year looking over their portfolio. Where stock investors who buy the shares of individual companies must stay up-to-date about the market trends and conduct research daily. They must remain familiar with the company’s business, their income statement, the financial ratios, its strategy and management to earn good returns.

But these funds cannot generate exponential returns like stocks as the index funds will give you returns matching the upside that the particular index it tracks.  However, if you wish to earn market-beating returns, then you can opt to invest in stocks. But if you want to participate in equities but do not want to take the associated risks then you can choose the index funds.

See Also: Expense Ratio of Mutual Funds

Investing in Stocks:

Investors who are looking for extremely high returns, investing in stocks seem to be a better option when compared to index funds. There is a good chance of getting better returns when compared to index funds. However, the risk factor is also very high in stock investments

Investors who bought the shares of successful companies in the past have gained exponential returns in the long run. The prices of their stocks have become ten-fold. Imagine if you become a part of NALCO or ICICI securities when they were small. As the profit of the company grows, you will be benefitted based on the total shares that were held by you.

However, you may also suffer huge losses due to the volatility of the stock market. Recent examples of corporate failure include jet airways, DHFL, Yes bank and reliance capital.

So it can be rightly said that your money in the right stocks may help you multiply your returns several times in a single year and it can also lead you to losses if you are not able to invest in the right stocks.

See Also: Index Funds Vs ETFs

The time and the speed at which you can lose money in stocks are completely unpredictable. This is true for other investment in options and futures or intraday trading as well; you may end up losing more money than you invested. This is because a sudden decline in the stock prices is enough to wipe out your margin money and make you liable for additional losses.

For risk-averse investors investing in an index fund is more advisable as it keeps the cost low and removes the need to constantly monitor the earning of companies. But stock investments can give you far better returns even in the short run. You should discuss it with your financial planner to decide which investment approach is the best for you.

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