Index Funds

I want to invest in an index fund. I want to institute an SIP, but find it inconvenient to monitor the balance in my savings account. I thought of keeping Rs 6,000 to Rs 12,000 in a MIP scheme and to replenish this after five months. Through this MIP I intend to institute an STP. Is it a right strategy?
-Ajay K. Jain

Your question requires a lot of parameters to be answered.

Understanding index funds: By definition, index funds track a particular market index by purchasing all the stocks of that index in same proportions as they are present in the index. This ensures a performance identical to that of the index they track, subject to tracking errors. Compared to actively managed funds, index funds are relatively low-risk-return equity instruments.

You have two options here. You can either invest in a fund which tracks the Sensex or one which tracks the Nifty. The Nifty (50 companies) is a broader index as against the Sensex (30 companies). These indices consist of shares of the largest companies and are also the most liquid. In short, a portfolio of blue-chips.

A third option is an index plus fund. These invest majority of their assets into a particular index, the residual amount is actively managed and can be invested in mid- and small-cap companies as well. HDFC Sensex Plus, UTI Index Select Equity and LIC Sensex Advantage Fund are examples of this class of funds.

Which fund you should invest in: This decision rests on two factors. The lowest expense ratio. Since the index fund manager doesn't have to spend time and money on research and in monitoring stocks, costs should be low.

Fund's tracking error. Tracking error measures how much an index fund's returns deviate from the benchmark index's return over any given period of time. The lower the tracking error, the better the fund is at keeping pace with its index. A poorly run index fund will generally have a large tracking error.

Mode of investment: The best option is an SIP. An option to your dilemma of keeping track of your savings account on a monthly basis is to institute a quarterly SIP, as against a monthly one.

The next best option is an STP, given the lump sum amount you already hold. However, an MIP may not be the best option here. Firstly, MIP's have a significant equity exposure that makes the returns volatile. In the very short term of a month or so, you may see your principal being eroded. Secondly, while most fund houses do not charge an entry load on MIP investments, a contingent deferred sales charge (CDSC) varying between 0.25 - 1.5 per cent is payable for redemptions made before 365 days.

A better option is to invest this corpus in a 5-star rated short-term debt instrument, with STP instructions to either an index fund or an equity diversified fund. There are three short term debt funds that charge CDSC, these are, HDFC Short- term, Kotak Bond Short-term and Principal Income Short-term.