Index fund

Key Takeaways

  1. The index fund is an exchange-traded fund or mutual fund.
  2. In India, BSE Sensex and NSE Nifty are preferred indexes for investment.
  3. Index funds offer portfolio diversification and low expense ratio.

An index fund is a passively-managed fund with its AUM invested in a benchmark index such as the Nifty50 and the Sensex, in order to replicate the performance of the benchmark index.

Index fund meaning

The index fund is an exchange-traded fund or mutual fund, which is designed to track specified investments. Many investors opt for index funds to diversify their portfolios. Index funds allow investors to approach the broader market for investment in indices such as Nifty and Sensex. Index funds aim for stability and not to outperform the market. Therefore many investors approach index funds to maintain the balance between risk and return in a portfolio. Index funds are passively managed funds. Therefore these funds have a low expense ratio. 

How to invest in an index fund?

The investment in the index funds depends on the investor’s investment goals and risk preference. Investors who want to invest in low-risk profiles with certain returns prefer to invest in index funds. Actively managed funds are preferred for long term investments. The return from actively managed funds and passively managed funds may match for short term investment. 

Since index funds are not actively managed, these funds focus on providing returns matching the underlying indices. In India, BSE Sensex and NSE Nifty are preferred indexes for investment. Index funds map the underlying indexes. Therefore these funds are less affected by volatile markets.

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The advantages of investing in index funds include:-

  • Diversification, as the AUM is invested in all the constituents of the benchmark index.
  • A lower expense ratio, as it is a passively-managed fund. The lack of active buying and selling and selecting securities reduces the expense ratio.

The disadvantages of investing in index funds include:-

  • Vulnerability to market fluctuations, as index funds suffer from market swings and crash just like the benchmark index
  • If you invest solely through an index, you will not be able to change any stock even if you know that the particular stock is undervalued or overvalued.
  • Investing in an index fund may not provide you access to many of the successful tactics that investors have employed in the past.