Investing in the stock market can often feel daunting, especially for those new to the landscape. There is an overwhelming range of options to choose from —actively managed mutual funds, thematic ETFs, sector-specific schemes, and more. Amid this complexity, one straightforward, low-cost option that’s steadily gained prominence is investing in index funds in India.

Index funds offer a disciplined, transparent approach to investing. They aim neither to outperform the market nor to pick winning stocks; instead, they are designed to faithfully replicate the performance of a chosen market index.

Let’s take a closer look at index funds in India.

What is an Index Fund?

An index fund is a passively managed investment fund that aims to track the performance of a specific market index. Rather than trying to beat the market, an index fund tries to match it.

For example, an index fund that tracks the Nifty 50 will invest in the same companies as the index, in the same proportion. If the Nifty 50 rises, the fund’s value should rise too, minus a small cost. If the Nifty 50 falls, the fund will decline as well.

In India, index funds typically follow major benchmarks such as the Nifty 50, the Sensex, Nifty Midcap 150, etc. The fund manager’s role in an index fund is limited. They are not trying to pick winners or predict market movements. Their job is to ensure that the fund’s portfolio stays as close as possible to the index it is tracking, making index funds a passive investment strategy.

Why Do Investors Choose Index Funds?

You might wonder, “If index funds don’t aim to beat the market, why bother?” It’s a fair question, and the answers lie in their practical advantages. Here are several reasons why index funds appeal to both new and experienced investors: 

1.  Low Cost

Index funds usually have very low expense ratios – the fees charged annually to manage the fund. Because these funds only mimic an index and don’t need expensive research teams or active trading, their expenses tend to be between 0.1% and 0.5% annually. Over long periods, lower fees mean more of your returns stay invested and compound over time, one of the biggest benefits of investing in index funds.

2. Transparency and Simplicity

With index funds, you know exactly what you own at all times. If your fund tracks the Nifty 50, you can easily look up its components – companies like Reliance Industries, HDFC Bank, Infosys, and ICICI Bank. There are no surprises or obscure small-cap stocks tucked away in the portfolio.

3. Broad Market Exposure

Index funds give you instant diversification across a broad range of companies and sectors. Instead of investing in a few stocks and hoping they do well, you participate in the entire index. This spreads your risk across multiple companies and industries.

What Risks Do Index Funds Carry?

While index funds look simple, they do come with risks investors must understand: 

1. Market Risk

When the stock market goes down, index funds go down too. They don’t have any special safety net or strategy to protect you during bad times. For example, in March 2020, when the COVID-19 pandemic scared investors, the Nifty 50 index fell by almost 35% in just a few weeks. Index funds that track the Nifty 50 also lost about the same amount, because they simply follow the index – they can’t avoid the downturn.

2. Concentration Risk

Indices often give a lot of weight to a few big companies or sectors – for example, the Nifty 50 is heavily tilted toward banking, energy, and IT. If these companies or sectors don’t do well, the whole index and your index fund will also struggle.

3. Tracking Error

Index funds try to copy their benchmark index as closely as possible. However, they rarely match it perfectly. The small difference between the index’s return and the fund’s return is called the “tracking error.”

This can happen for a few practical reasons. Index funds need to keep a small amount of cash on hand to manage day-to-day operations or pay investors who sell their units. They also charge a small fee every year, which slightly reduces returns. Plus, when companies are added or removed from the index, it takes time and some trading costs for the fund to make those changes. Each of these small factors adds up gradually. Even so, most well-run index funds manage to keep their tracking error very low. 

Expected Returns from Index Funds

Over the long term, ideally more than 5 years, best index funds for long-term growth tracking broad indices like the Nifty 50 or Sensex have historically delivered good returns. However, these returns fluctuate with market conditions and may be lower in some years and higher in others.

Investors who embrace a long-term horizon tend to benefit most. Periods of underperformance and short-term volatility can feel unsettling, but patient investors often find that the market’s broad growth trajectory smooths out these fluctuations.

This predictability in knowing that an index fund will rise and fall with the economy and the market as a whole is one of its most appealing features for disciplined investors.

Who Should Consider Index Funds?

Index funds are well-suited to investors who: 

a. Seek long-term wealth accumulation through equity exposure without the need for constant portfolio reviews.

b. Value transparency and cost-efficiency over attempts to time the market.

c. Have an investment horizon of more than 5 years.

d. Prefer a hands-off investment style that captures broad market growth rather than aiming for outperformance. 

For most individual investors, especially those balancing investing alongside full-time careers and other commitments, index funds offer a prudent and highly efficient option to manage their wealth.

How to Invest in Index Funds?

Getting started with investing in index funds is simpler than you might think. All it takes is a few steps on our platform share.market, to get you started. Here’s how you can start investing in index funds right away:

  1. Open your Share.Market app
  2. Head to the Discover Tab
  3. Click on Mutual Funds
  4. Scroll down to ‘Browse by Category’
  5. Click on Index 
  6. Select a fund and start investing

Conclusion

Index funds may not seem flashy or exciting, but they are one of the most straightforward and affordable ways to grow your money over the long term. They give you exposure to a broad range of companies, charge low fees, and deliver returns that closely match India’s top indices like the Nifty 50 or Sensex. This lets you benefit from the market’s overall growth without worrying about picking the “best” stocks or timing the market.

Index funds do have some risks, and they may not be right for everyone. But for most people who want a clear, easy investment that can grow their money slowly over time, index funds are a smart and practical option.

FAQs

1. What’s the difference between an index fund and an actively managed mutual fund?

An index fund simply follows a market index like the Nifty 50 or Sensex. Its goal is to match the index returns. In contrast, an actively managed fund is run by a fund manager who picks and chooses stocks they believe will do well. Active funds aim to beat the market while index funds aim to match it.

2. Can index funds lose money?

Yes. Index funds go up and down with the stock market. If the index they follow falls, the index fund will also drop. Index funds do not protect you from losses during downturns, but they move in line with the overall market.

3. How do index funds charge fees?

Index funds have very low expense ratios – typically between 0.1% and 0.5% per year. These fees are automatically deducted. 

4. Are index funds suitable for beginners?

Yes. Index funds are a good option for new investors. They’re simple, transparent, and require minimal knowledge of the stock market. Because they track broad indices, they also offer instant diversification across companies and sectors.

5. Do I need to monitor my index fund regularly?

Not necessarily. Index funds require very little ongoing monitoring. Once you’ve invested, you can focus on other financial goals. It’s still a good idea to review your investments once or twice a year to make sure they align with your plans.