How to Invest in Nifty 50 Index Fund? Risks & Challenges

Index funds are mutual fund schemes designed to replicate the performance of a stock market index, such as the Nifty 50. Generally, an index fund invests in the stocks that comprise a specific market index, maintaining the same weightage as each stock.

If any stock’s weightage changes, fund managers adjust the portfolio to ensure it mirrors the composition of the index it tracks. Nifty 50 index fund is one example of this investment option.

A Nifty index fund can be a good choice for investors who want equity exposure but prefer to avoid high-risk investments. However, it is crucial for investors to thoroughly understand this investment option before exploring how to invest in Nifty 50 index fund.

This article serves as a Nifty 50 index fund investment guide to help you get started.

What is a Nifty Index Fund?

A Nifty 50 index fund is a type of mutual fund that primarily replicates and tracks the performance of the Nifty 50 index, which represents the 50 leading companies listed on the National Stock Exchange (NSE). The index includes large-cap companies with significant market value and actively traded stocks that play a key role in India’s economy.

Since a Nifty 50 index mutual fund is passively managed, the fund manager’s involvement is relatively less. The fund usually invests indirectly in all 50 companies of the Nifty 50 Index. The primary goal of Nifty Fifty index funds is to deliver returns that closely align with those of the market index.

Before we discuss ‘how to invest in Nifty 50 directly,’ let us look at what makes Nifty index funds unique.

What Makes Nifty Index Funds Special?

Now you understood the meaning of Nifty Index Funds or What is a Nifty 50 index fund?; now it is time to understand a few points that highlight what makes them special:

Diversification

Nifty Index Funds help diversify your portfolio. This indicates that your funds are distributed among companies in various sectors. If one sector does not do well, gains from other sectors can balance things out. This way, your portfolio may stay more stable even if some companies face problems. Diversification can reduce risk and create a more balanced investment strategy.

Low-Cost Investment

One of the main reasons people choose Nifty index funds is that they are low-cost. These funds are passively managed, so the fund managers do not have to decide which stocks to buy constantly. As a result, the management fees are lower, which can lead to a reduced expense ratio. Nifty Index Funds could be a good investment option if you’re looking for a budget-friendly investment.

Flexibility

Nifty index funds are flexible because you can invest either in a lump sum or through a systematic investment plan (SIP). The choice depends on how you want to invest. The SIP route allows you to allocate a fixed sum to an index fund scheme at regular intervals (monthly, quarterly, etc.). You can invest in Nifty index funds with a SIP for as little as ₹500.

No Bias in Investing

For index funds, fund managers adhere to an automated investment strategy. Specifically, they operate with a clear mandate that dictates which stocks to purchase or sell and in what proportion. Their decisions are not based on emotions or gut feelings, eliminating the possibility of human bias in investment decisions.

Why Invest in NIFTY Index Fund?

There are several advantages of investing in NIFTY 50 index funds in comparison to regular mutual funds. Here are a few important ones you should know before choosing to invest in it:

Reduced Risk

NIFTY 50 Index Funds may have lower risks compared to other mutual funds because they replicate the performance of the NIFTY 50 Index. They offer broader market exposure and effective portfolio diversification. The underperformance of a single sector does not heavily impact the index, as it covers nearly all major industries and sectors.

Consistent Returns

These funds offer immense potential for future growth and provide more consistent returns. Unlike individual stocks that can be highly volatile, NIFTY Index Funds provide stable and predictable returns over time. As the index reflects the overall market sentiment and economy, it creates opportunities for growth without depending solely on the performance of any single company or sector.

Elimination of Bias

Investing in a NIFTY Index Fund eliminates emotional bias. The stock selection process is completely objective because the fund is built to mirror the NIFTY Index. Since it follows the NIFTY 50 Index, there’s no scope for emotions to influence investment choices. This keeps the portfolio aligned with the index’s performance, ensuring a more disciplined and unbiased approach to investing.

How to Invest in a Nifty Index Fund Directly?

You can invest in the NIFTY 50 index fund in different ways. Below are a few of them:

NIFTY 50 Investment Via ETF

A straightforward way to invest in the NIFTY 50 index fund is through NIFTY 50 ETFs. These exchange-traded funds can be bought and sold like any other stock listed on the stock exchange. They provide investors with exposure to the entire index through a single asset, aiming to replicate the index’s performance.

NIFTY 50 Investment Via Index Funds

Another option for investing in the NIFTY 50 is through index funds. These mutual funds track the performance of the NIFTY 50 index and seek to mirror its performance by investing in the same 50 stocks that make up the index.

NIFTY 50 Investment Via Derivatives

Derivatives, such as futures and options, also offer a way to invest in the NIFTY 50 market. These financial instruments derive their value from an underlying asset, in this case, the NIFTY 50 index. However, investing in derivatives can be riskier and more complex than investing in index funds or ETFs.

Things to Consider Before Investing in a Nifty 50 Index Fund

Before investing in the Nifty 50 index fund, you must understand a few things, such as the following:

Investment Objective

Before investing, ensure that the fund aligns with your financial goals. Nifty 50 index funds are designed for long-term growth and may suit investors seeking stable returns with lower costs. Since they replicate the performance of the Nifty 50 Index, they may not deliver extraordinary returns but offer steady growth in line with the market. Make sure this matches your investment horizon and risk tolerance before proceeding.

Tracking Error

Tracking error represents the difference between the fund’s actual returns and the index it tracks. As index funds replicate the performance of the Nifty 50 index, slight deviations can occur due to tracking errors. A lower tracking error indicates better fund management and performance. So, it’s a good idea to check a fund’s past tracking error before investing to make sure it consistently delivers returns that are close to the benchmark.

Expense Ratio

Nifty 50 index funds usually have lower expense ratios. This is because they are managed passively rather than actively like other mutual funds. Fund managers may not need to research or select stocks actively. A low expense ratio means fewer costs passed on to investors, allowing more of your investment to grow. Comparing expense ratios across funds can help you choose the most cost-effective option, ensuring better returns in the long run.

Limited Investor Control 

Investors have minimal influence over the index’s composition. This can be disadvantageous during market downturns, as there is no opportunity to adjust holdings based on personal preferences or prevailing market conditions.

Restricted Structure 

The Nifty 50 index is limited to a specific group of 50 stocks. This could restrict exposure to emerging sectors or individual companies, potentially limiting growth opportunities and returns.

Taxation of Gains from a Nifty 50 Index Mutual Fund

Index funds usually invest at least 95% of their net assets in the Nifty 50 Index constituents. Therefore, tax laws classify them as equity-oriented mutual funds, and equity mutual fund taxation applies.

On redeeming the units of Nifty 50 index mutual funds, the gains, if any, will be taxed at:

• Short-term capital gains: Gains from Nifty 50 index mutual funds will be taxed at 20% if units are sold within 12 months of investment.
• Long-term capital gains: Gains from Nifty 50 index mutual funds will be taxed at 12.5% if units are sold after 12 months and exceed 1.25 lakh in a financial year. Gains up to ₹1.25 lakh in a financial year are tax-free.

Also, if dividends are distributed, they will be taxed according to the investor’s income tax slab.

Risks & Challenges of Investing in Nifty Index Funds

Following are the risks & challenges of investing in Nifty Index Funds:

Market Risk

Nifty 50 represents the Indian stock market. Any economic slowdown or global event can strongly affect the index fund’s performance. This can have a negative impact on your returns.

Sectoral Risk

Nifty 50 includes stocks from various sectors. If any significant sectors underperform, the entire index can be affected, especially when those sectors hold a significant weight.

Poor Market Timing

Investing in Nifty 50 at the wrong time can lead to underperformance. For example, buying when the market is going through a bearish phase can result in lower returns and more extended recovery periods.

Not Enough Diversification

Nifty 50 does not fully cover all sectors of the Indian economy. Emerging industries may not be well represented, which limits exposure to new growth opportunities.

Who Should Invest in Nifty 50 Index funds?

Nifty 50 index funds may suit investors looking for long-term growth with low maintenance. These funds track the Nifty 50 and require no stock selection, which is beneficial for those who prefer passive investing.

Beginners can invest since the fund provides exposure to India’s top companies, reducing individual stock risk. Investors seeking diversification can also consider it, as the index covers multiple sectors.

Those with a long investment horizon can gain as markets grow despite short-term fluctuations. Investors who want lower costs can choose these funds, as they have lower fees than actively managed funds. People willing to stay invested during market ups and downs can invest. Since returns depend on market performance, patience and discipline are necessary for success.

Conclusion

Now that you understand how to invest in Nifty 50 index funds, compare the top Nifty 50 index funds in India before investing. Investing in a well-performing Nifty Index Fund can boost your chances of achieving financial goals more quickly. Even if you’re not experienced with the stock market, there’s no need to worry about managing the fund. Your fund manager will professionally and passively oversee it.