Should you invest in Nifty or Sensex index fund?

Talking about the instructions he has laid in his Will, he said: “My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”

Many investment advisors in India have been asking clients to make index funds as part of their core portfolio. But in the country, there are two popular indices – S&P BSE Sensex and Nifty 50. The former has 30 stocks while the latter has 50. If you have to invest in an index fund, should you choose one over the other?

According to investment advisors, either of the two is fine. “Both the indices have similar historical returns,” said Chandan Singh Padiyar, a Sebi-registered investment advisor.

He further explains: “They both represent the weighted average of the largest Indian companies, and the top 20 companies have the most weight. The remaining are small.”

To simplify, it means, when you invest in an index through an index fund, the investments are made based on the weight of each company. For example, an investor puts ₹100 in an index fund. Reliance Industries Ltd and HDFC Bank have a weight of around 23-24%. The fund manager will allocate ₹23 of the ₹100 invested in these two companies.

But do 30 companies provide enough diversification? “Anywhere between 30-50 stocks are good enough for diversification,” according to Padiyar.

When choosing an index fund, make sure you go for the one with higher assets under management (AUMs). Higher AUM is better in case there is redemption pressure on the fund.

Ensure that the fund you choose also has a low expense ratio. Zero down on a fund that has returns similar to that of the index it’s tracking.

The difference between the fund’s and the index’s returns is called tracking error. The lower, the better. However, up to 1% tracking error is usually acceptable.