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Is it advisable for a first-time investor to invest in index funds?

Ashutosh Gupta talks about the benefits of index funds and why they can be a suitable option for a first-time investor

I am a first-time investor and don't know where to invest. I've been suggested index funds. Are they suitable?
- Ritu

Well yes, I think index funds can be a suitable option for you. In case of a new investor, the biggest advantage that index funds provide is that they greatly simplify choice, because the only two parameters that matter in the case of index funds are expense ratios and tracking error. One can simply go with a fund which offers one of the lowest combinations of expense ratios and tracking error. The other big advantage of index funds for a new investor is that they are largely confined to a universe of large-cap stocks, which I believe is more suitable for a new investor because these stocks tend to be relatively less volatile with the ups and downs of the equity market than the mid caps and small caps. This helps new investors familiarise themselves with the way equity markets work, without making them panic away from the markets if they were to drop suddenly. So from these perspectives, index funds do appear to be a reasonably good choice.

But I will also suggest that you look at aggressive hybrid funds which we generally suggest to new investors. This is because these funds invest about 25 per cent of your money in bonds which do not rise or fall with the ups or downs of the equity markets. Thus, their presence in the portfolio provides a much-needed cushion when equity markets witness a sharp correction. That can be a great source of comfort for a new investor.

So, I suggest you can look at index funds or aggressive hybrid funds for your investment needs and more broadly, I suggest that you remain disciplined through the ups and downs of the market and continue to invest without being too fazed by periods of exuberance or sharp market corrections and if you do so, then by and large you should be fine.

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