What is an index fund and how can one invest?

Mr Pranjal Kamra, CEO, Finology

Since 2017, Sensex – which is a 30-stock market barometer at BSE – has clocked a growth of more than 76%. In other words, it has extended more than 15% annualized returns. This figure is obviously over and above the dividend paid by the listed companies during the tenure. Simply put, the returns are even better than some of the leading mutual funds. This brings us to the question that: will it not be better if you invest in an index fund? If so, how to do it?
But what are index funds? Let’s find out.
What are Index Funds?
As implied by its name, index funds typically invest in some index such as Sensex, Nifty, BSE 100, etc. These are also called benchmark indices as they are used as a reference to measure the performance of mutual funds. So, when they are a barometer for segment-specific mutual funds, why should one not rather invest in them? This is precisely the idea that index funds build on. Such funds invest in market indices and emulate their performance by achieving the same share of securities as that of an index.
Across western economies, index funds have become quite popular over the yesteryears. It is because blue chip stocks have the potential to deliver consistent returns with lower downside risks. So, passively managed funds comprising them (such as index funds) tend to outperform actively managed mutual funds.
Index funds also help in diversifying your portfolio and adding stability to the same. Studies also indicate that benchmark indices are very hard to beat, especially in the long haul. Therefore, if you are having trust issues with your Mutual Fund (MF) house, you must consider investing in index funds. First-time investors can also adopt this approach to step into equities.
Are Index Funds popular in India?
No, they are not. At least, they are not as popular as they should have been. There are several Index Funds in India issued by different MF houses as there are also Exchange Traded Funds (ETFs) that invest in indices. You can also explore other indices such as Bank Nifty as well as Midcap- and Smallcap-centric indices on different exchanges (such as BSE and NSE). However, you should be aware of their respective volatilities and risks associated, if any.
How to find a good Index Fund?
The performance of any index fund is gauged by how successful it is in emulating the returns of the index that it is based on. Tracking error – which reflects the deviation of a fund’s position from the benchmark index – helps in determining the same. You should ideally aim for an Index Fund that has lower tracking error.
In addition to the aforementioned benefits, here are some additional benefits of investing in index funds:
It eliminates human biases and inaccuracies
It is a low-risk, cost-effective approach towards investing. The expense ratio as compared to an actively managed fund is less than half
It generates the best results in the long-term horizon. Historically, index funds have outperformed most of the actively managed funds
How to Invest in Index Funds?
You can check out Index Funds and ETFs issued by leading MF houses in India (or abroad for that matter). Pay special attention to all charges incurred by your index fund to reap the most optimal returns. Some of these charges include exit load, management fee etc. For buying an index you can either visit the Mutual fund company branch or you can directly buy it from the company’s website. Alternatively you can invest your money with the help of an online mutual fund platform like Groww, Paytm Money, ET Money etc. Inorder to invest in an ETF, you need to have a Demat account with registered broker.