What are index funds?

An index fund is a type of mutual fund which have a portfolio constructed to match the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). These replicate the performance of market benchmark.

Various characteristics of these funds are:

• Market exposure is not adequate- inadequate diversification
• Operating expenses are low- lower management expense ratio on an index fund
• Funds are managed as per specific rules or standards (e.g. efficient tax management) and these are adhered to irrespective of the market condition
• Meant for long term investments and investors whose risk appetite is low
• Meant to achieve the gains as that of the market

Index funds are different from mutual funds on the following parameters

• Index funds are not as actively managed as mutual funds
• Aim- mutual funds aim to beat the market performance whereas the index funds aim to replicate market performance
• Less fees is paid in case of index funds than as compared to mutual funds

Index funds is a category of mutual funds where the stocks in the fund are exactly same as the index from which they are derived. Index funds are passive funds which means that the portfolio of these funds is not changed very frequently until and unless there is some change in the index stocks.

Index funds offer very good diversification benefits as these funds have stocks from all the sectors and therefore represent entire economy of a country. These funds have very low expense ratios because of the low churn rate of the portfolio.

The risk involved in these funds is between moderate and high depending on the index. Investors who are more interested in the more modest objective of having an equity growth component in their portfolio, rather than the more aggressive objective of beating the equity market benchmark, would be better off investing in an index fund. This again does not mean that the NAV of an index fund will not decline in value. If the bench mark index goes down, then the NAV of the index fund too will go down. If the investor has a long enough horizon, then his investment will do well, in line with the overall market. Amongst index schemes, tracking error is a basis to select the better scheme. Lower the tracking error, the better it is.

Index fund is a type of mutual funds but differ from traditional schemes in terms of their passive strategy, expense ratios and risk involved.

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Some of the index funds trading in India are:

Index funds are mutual funds which are designed to track the returns of a whole market index such as Nifty, Sensex,etc . These funds purchase all the stocks in the same proportion as it is in a particular index.

• They can be considered passively managed funds as the portfolio of these funds is exact replica of the index.
• For example, Nifty 50 index has stocks of 50 companies of India from different sectors. By investing in Nifty 50 index funds, you are passively investing in those 50 companies.
• As the name suggests, these funds passively track the performance of an index.
• Since the portfolio is not actively managed by the fund managers, these funds require fewer expenses.
• Due to the lower expenses, these funds have advantage of low cost to investors.
• These funds are less popular in India, as there are many actively managed funds which can provide higher returns to investors.

Top performing index funds:

For index funds, whole index of stock market is used as an instrument of investment. Index funds buy all the stocks in a particular index in the same proportion as its respective index, thereby performing in coherence with the index.

Three options are available in India for investing in index fund:

1. The Sensex having 30 companies
2. The Nifty having 50 companies
3. An index plus fund- mixer of investing in index and partially in actively managed assets

Index funds are different from mutual fund mainly in three ways:

1. Mutual funds portfolio does active stock picking to park money of investors, whereas index funds passively follow the performance of a particular index.
2. Index funds are meant to mimic the performance of the index. But mutual funds are meant to outperform the index.
3. As index funds are passively managed, it helps to keep cost low as compared to other actively managed mutual funds.

Index funds are popular in developed countries like US and are yet to make foothold in developing countries like India, as there are number of companies growing more than index.

Happy Investing!

Index funds are investment funds that are created to replicate the performance of market benchmark or index. Index funds behave like a market index tracker and invest in the same ratio as a particular index such as Nifty, Sensex, etc.

Some features of an index fund are:

• Lower turnover along with a lower expense ratio
• Suitable for investors who are looking for a safe side of investment which mimics the returns of the market index
• Meant for long term investment with very low costs
• Not meant to beat the market but achieve the same gains as the market
• Absence of adequate diversification
• Does not require insight or foresight

Mutual funds vary from index funds on 3 main parameters:

• Investments the fund holds
• The fund's investment objective
• Fees to be paid by investor