Index Funds

Index Funds are mutual funds that track a specific market index, such as the Nifty 50 or Sensex, by investing in all the companies within that index. These funds aim to replicate the performance of the index rather than beat it, making them a low-cost, passive investment option. Learn about the best Index Funds in India, their types, how they work, the differences between index and actively managed mutual funds, and tips on selecting the right fund. 

What is an Index Fund?

Index funds are mutual funds that follow an Index. For example, the Navi Nifty 50 Index Fund tracks the Nifty 50 Index. Similarly, the ICICI Prudential BSE Sensex fund mirrors the Sensex Index. This means that these fund invests in all the companies in the Nifty 50 Index and the Sensex respectively.

These indices serve as a benchmark for mutual funds. In this example, the objective of the Navi Nifty 50 Index Fund is to track the holdings and performance of the Nifty 50 Index as closely as possible. Unlike other mutual funds, these funds do not aim to beat the benchmark index; they just try to mirror the index's returns accurately.

Best Index Mutual Funds in India

List of the top-performing Index funds sorted by returns with their AUM and Expense Ratio.

How do Index Funds work?

Index funds let you invest in India’s top market indexes, which reflect the country’s broader economy. For example, the Nifty 500 tracks the top 500 companies by free-float market capitalization. A rising index signals investor confidence, while a falling one indicates caution.

When you invest in an index mutual fund, you’re buying into a portfolio that includes all the companies listed in that index. For example, a Nifty 50 Index fund invests in the top 50 companies across various sectors that form the Nifty 50 index. The fund holds these stocks in the same proportion as the index, ensuring that its performance closely mirrors the index’s movements

Index fund returns move in line with the market. As the index rises, the fund’s Net Asset Value (NAV) increases, and when it falls, the NAV decreases. Investors earn through NAV appreciation, and any dividends declared by the companies are either reinvested or paid out, depending on your mutual fund plan.

How to invest in Index Mutual Funds?

You can easily invest in Index Mutual Funds on INDmoney. To do so, follow the steps below:

Step 1: Download the INDmoney app and create your free account.

Step 2: Look for the ‘Mutual Funds’ section in the bottom menu bar.

Step 3: Search or look for ‘Index Funds’. 

Step 4: Explore and analyse all the Index funds available.

Step 5: Choose whether to SIP or invest in a lump sum and start investing.

What are the types of Index Funds?

There are multiple types of Index funds. Indexes are created based on their market cap, sector, broader market, and more. Here are the top types of Index funds that you will come across:

1. Broader Market Index Funds

Broader market index funds represent a segment of the total stock market. For example, the Navi Nifty 50 Index Fund tracks the top 50 companies of India by their market capitalization. Similarly, Nippon India Nifty 500 Momentum Fund tracks the top 500 companies of India that are showing price momentum. These funds represent how the overall market across different sectors is doing.

2. Market Capitalization Index Funds

Index funds are also categorized on the basis of their market cap. This includes large-cap, small-cap and mid-cap companies. For example, HDFC Nifty Smallcap 250 Fund matches the performance of the NIFTY Smallcap Index which includes companies ranked from 251st and beyond on the stock exchange.

3. Sectoral Index Funds

Indexes are further segmented into different sectors. This includes indexes like Banking, Financials, IT, Healthcare, etc. So, for example; Axis Nifty IT Index Fund tracks the NIFTY IT index. This index includes all IT companies and represents how IT companies are performing as a whole.

4. Equally Weighted Index Funds

Index funds are also categorized by their weight. Usually, allocations in these indexes are based on their weighted market cap. With an equally weighted approach, all stocks in the index have equal allocation, ensuring a more diversified and balanced approach.

What is the difference between Index Funds and Mutual Funds?

Index funds are a type of mutual fund. What sets the two apart from each other is how they are managed and their objective. 

Index funds are passively managed while mutual funds are actively managed. Index funds track a particular index and their objective is to match the performance of the index as accurately as possible.

While in the case of mutual funds, the fund manager actively picks stocks, takes the index as a benchmark and aims to outperform the returns of the index.

Actively managed mutual funds have a higher expense ratio, while Index funds have a relatively lower expense ratio.

Should I invest in an Index Fund?

Index funds are an appropriate choice for investors who want returns in line with an Index. Whether you should invest in an Index fund or not depends on your investment goals. Investors who invest in index funds often have these characteristics:

1. You are a passive investor 

If you are new to investing and do not want to individually pick stocks or rely on a fund manager. Following an index might work better. It is a passive investment approach that follows the set it and forget it strategy.

2. You are risk-averse

If you have low risk tolerance and do not want to invest in funds that are volatile and risk your capital, a passive approach like index investing might work well.

3. You want market-average returns

When you aim to get returns that align with the market. You do not aim for market-beating returns but are satisfied with stable market-average returns; index funds may be a good fit.

How to choose the right index fund?

There are several index mutual funds to choose from. Here’s a step-by-step guide on how to pick the best index mutual fund for yourself:

1. Identify the right index: Indexes differ by market cap, sectors, weightage, etc. The first step is identifying the index you would like to invest in. Explore your options and select the one your investment goals align with.

2. Check the expense ratio: The expense ratio is a fee charged for managing your investments in the fund. While index funds are not actively managed, they still charge an expense ratio. The less you pay as an expense ratio, the more you get as returns.

3. Look at the tracking error: The tracking error is the difference between an index and an index fund. The index fund tries to match the index as closely as possible, however, tracking error remains a possibility. See that tracking error on your fund is as low as possible.

There are a few other metrics that you should consider, like fund size, fund house reputation, etc. to further take an informed decision.

Benefits of investing in an Index mutual fund

There are several benefits of investing in an index mutual fund. Some of which are:

Market Exposure

When you invest in an index fund, your portfolio is exposed to the broader market. This essentially means that you get exposure to top companies in India. If you invest in a Nifty 500 index fund, you are indirectly investing in the top 500 companies. Similarly, say you invest in an IT Index Fund, you are then investing in the top IT companies of India.

Cost Efficiency

Index funds are a cost-effective way to invest. You can start with as little as ₹500 through SIP or lump sum investments. Instead of buying individual stocks, you invest in a basket of companies through a single fund. Plus, the expense ratio is significantly lower compared to actively managed mutual funds, ensuring better long-term returns

Long-term Growth

Since index funds mirror the overall market, they benefit from the long-term growth of the economy. Over time, markets tend to rise, making index funds an ideal choice for wealth creation. Patience rewards investors with steady, compounded growth.

Diversification

By investing in multiple companies through an index fund, you minimize the impact of individual stock volatility. Diversification helps balance out risks and protects your portfolio from major market fluctuations.

What are the risks associated with Index Funds?

As an investor, you must also be aware of the risks associated with Index Funds. Some of which include:

Market Risk

Index funds are designed to mirror the performance of the market. But when the market takes a downturn, these returns also dip. Since stock markets go through inevitable highs and lows, investing in an index fund means you need to be prepared to face the risk of downturns.

Portfolio Concentration

Many index funds, especially those tracking market-cap-based or sector-specific indices, tend to have a heavy concentration in certain sectors. This lack of diversification can expose your portfolio to higher risks if those sectors or stocks underperform.

Lack of Flexibility

Unlike actively managed funds, index funds passively follow their benchmark and cannot adjust their holdings during market volatility. This means they can’t take defensive positions or capitalize on market opportunities, leaving your investment exposed to broader market trends.

Tracking Error

Although index funds aim to replicate the performance of their underlying index, factors such as fund expenses, rebalancing delays, and dividend reinvestment may cause slight deviations in returns, known as tracking error. Over time, even small deviations can affect overall performance.

Are Index Mutual Funds taxed?

Taxation on index funds is similar to that of other equity mutual funds, and it involves two main components: capital gains and dividends.

Short-Term Capital Gains (STCG)

If you redeem your index fund units within 12 months of investment, any gains are classified as short-term capital gains. These gains are taxed at a rate of 20% plus applicable cess.

Long-Term Capital Gains (LTCG)

For units held for more than 12 months, the gains are classified as long-term capital gains. LTCG is taxed at a rate of 12.5% on gains exceeding ₹1,25,000.