Mutual Funds
Index Funds in India - Complete guide to Index Funds
Index funds can be defined as a low-cost way to invest in stock markets. They are based on indexes like SENSEX, S&P 500, or NIFTY and mirror the performance of these underlying indexes. It is the most passive and unimaginative way of investing in the stock market. The index funds save the investor from the expert's or fund manager's biases and are especially recommended in the buy-and-hold model for at least 5 years.
What is an Index Mutual Fund?
Index Mutual Funds are passively managed funds, wherein the fund manager tries to reduce the risk factor by mirroring the index. In simple terms, it replicates the performance of an index by buying all the same stocks and in the same proportion as the index. These Index funds do not tend to beat the index by actively stock picking, rather they just replicate the performance of the index. One of the major advantages of index funds is that they have a lower expense ratio compared to any other equity mutual funds. Also, investing in Index funds has a comparatively lower risk. Therefore, investors who have long-term financial goals with medium risk appetite should invest in such funds.
Several researches have proved that beating the benchmark index every year is quite impossible. The funds that are actively managed by managers have failed to beat the market a few times in the past. In such circumstances, the index funds have proved to generate better returns by just tracking the index performance.
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Top 5 Index Funds to Invest in 2024
As we are talking about the top 5 index funds, here are the best mutual funds to invest in 2024:
| Top Index Funds 2023 | NAV | Fund Size | Expense Ratio |
|---|---|---|---|
| Bandhan Nifty 50 Index Fund | ₹41.95 | ₹855 Cr | 0.1% |
| UTI Nifty 50 Index Fund | ₹131.88 | ₹12,048 Cr | 0.2% |
| ICICI Prudential Nifty 50 Index | ₹198.52 | ₹4,930 Cr | 0.17% |
| SBI Nifty Index Fund | ₹175.46 | ₹4,796 Cr | 0.18% |
| Tata Nifty 50 Index | ₹127.86 | ₹475 Cr | 0.2% |
How do Index Funds Work?
Index funds work in a simple and cost-effective manner. Unlike actively managed funds, these passive index funds tend to deliver better results due to long-term commitments and diversified portfolios. In index mutual funds, a fund manager simply buys all the stocks in a particular index in the same proportion as that index holds and then issues units of the fund to different investors on a pro-rata basis. The fund only tracks the performance of the index, generating more or less the same returns. No active decision is made regarding stock selection, and the fund is rebalanced only when a change takes place in the index itself — which occurs rarely.
For example, a Sensex Index Fund invests in the stocks of companies comprising the Sensex 50 Index in the same proportions. If the Sensex 50 Index has a weightage of 17.79% for Bharti Airtel, the Sensex Index Fund will also allocate 17.79% to Bharti Airtel to match the returns of the Sensex 50 Index. Similarly, if any share is removed from the Sensex 50 Index, the fund manager will remove it from the Sensex Index Fund. If the weightage of any share changes, the same adjustment will be replicated in the index fund.
Index funds exist widely in the financial market and investors can choose as per their expectations e.g. If an investor is interested in the energy and economic sector, he can select a benchmark index and can easily find a group of investment stocks giving similar returns from his preferred sector.
Index funds do not actively monitor or time the market movements that is the reason its expense ratio is also low. Also it helps funds to increase market exposure and diversification.
Who should invest in an Index Fund?
- Index funds are a low-cost and easy way of investing in stocks, so they are most suitable for beginners.
- The investor who doesn't want to take extra risk and wants their investment safe can invest in index funds. As these funds mimic an existing index, the investor can easily hold a wide range of diversified stocks without individually selecting the equity or other financial instruments.
- Investors who don't want to track the performance of their mutual fund can invest in index funds as these funds mirror the assets as well as the weight given to each asset in the underlying index to mirror the performance in the long term.
- The index funds tend to give a better result when held for 7 years or more. So investors who are looking for low risk and high returns in the long run must invest in Index funds. As they are not managed on a day-to-day basis, they might fluctuate in the short term but tend to average out in a longer period.
Advantages of Index Funds
- Due to the passive strategy, the overall expense ratio is low for index funds. It makes the product cost-efficient and affordable for the investors. Fund managers here do not select particular stocks but just mirror the said index, saving the fees.
- Due to high diversification and broad market exposure, the risk is minimized and spreads out in different market capitalizations, sectors, and types.
- As the index which the fund is mirroring has shown long-term growth and has performed well over the years, it has more investor confidence.
- Due to its long-term nature and capital gains, it is considered a tax-efficient investing method.
- It hedges the investor from the risk of poor performance of a single company stock by giving a group of diversified investments.
Drawbacks of Index Funds
Apart from the advantages stated below, there are only a few downsides to Index funds.
- There is no lower cap for losses in index funds, so in cases of losses, there is no hedge on the lower limit.
- As the index funds exactly copy the underlying index, the investor does not have the liberty to add or subtract any of the individual holding or asset.
- The returns achieved are generally equal to or lower than the market returns.
- In the short term, the value of the funds can fluctuate on the negative side and that is why it is only preferred for long-term investments.
How to Invest in Index Funds in India
Before we dive into how you can invest in index funds, let’s know the documents you’ll need to invest:
Documents Required for investing in Index Funds
- Identity Proof (Aadhar Card)
- Canceled cheque
- Passport size pictures
- PAN Card
- KYC Documents
Now, let’s dive straight into the question, “How to invest in Index funds in India”. Below are both the ways, online and offline, to invest in index funds:
Online Process for investing in Index Funds
Step 1: Visit the ZFunds website and open a mutual fund account.
Step 2: Finish all of the KYC procedures and move on to the next step.
Step 3: Enter all the necessary information required.
Step 4: Now, choose the index fund you want to invest in.
Step 5: Once you have chosen the fund, transfer the required amount and invest.
That’s all you need to do to invest in the best index fund of 2024!
Offline Process for investing in Index Funds
Step 1: Visit the bank and fill out the application form and KYC form carefully. Then submit both of them.
Step 2: Add in and fill out the necessary information as required.
Step 3: Choose the fund that you want to invest in, as per your requirements.
Step 4: Pay the investment amount.
Bonus Tip: If you wish to invest in SIP, set up BillPay, eMandate, eNACH, ADF, or OTM anywhere digitally or offline.
How to Select the Right Index Fund?
While investing in an index fund may be a good idea, choosing the right index fund is not as it sounds. A lot of factors come into play, and here are the four major factors to choose the right index fund:
1. Expense Ratio
The expense ratio is the amount that is charged by the fund house to invest your money. This expense ratio includes various expenses that the fund house incurs such as management fees, marketing and administrative expenses, etc.
However, the good news is that the expense ratio for index funds is relatively lower than the actively managed funds. Here’s why: Index funds are passive funds and so, they don’t require enough attention from fund managers.
Still, you should note that the expense ratio may vary from fund to fund. So, you should consider the expense ratio of the funds that you choose before investing.
2. Asset Under Management (AUM)
Asset Under Management, also known as AUM, is the total fund amount. The high AUM of a fund indicates that it is popular and has gained large investments from numerous investors.
So, if you’re unsure of which fund to choose, go with the funds with high AUM. This way, you will have a safer investment path since the market trusts the fund.
3. Fund Manager
Although a fund manager’s role isn’t very necessary in index funds, you should still consider this factor. Check which funds the fund manager has managed before, and what their historical performance has been like.
4. Past Performance
Lastly, checking the past performance of a fund will show you what its average growth rate has been like. So, you will have a better idea of what the returns would be like.
In any case, you must note that if a fund’s past performance has been good, it does not guarantee good returns in future as well. However, it is a valid criteria to compare different index funds.
Taxation on Index Funds
Index funds come under the category of equity funds and hence are taxed like other equity funds. The gains from these funds are taxed as Long-Term Capital Gains (LTCG) and Short-Term Capital Gain Tax (STCG).
If an investor redeems the units within the period of 12 months from the date of investment, the gains from the investment will be taxed as STCG. As per the Income Tax Act, 1961, short-term capital gains are taxed at 20%.
If an investor redeems the units after the period of 12 months from the date of investment, the gains from the investment will be taxed as LTCG. As per the Income Tax Act, 1961, long-term capital gains are taxed at 12.50%. LTCG is taxed on the gains which exceed Rs. 1.25 lakh per financial year.
Frequently Asked Questions (FAQs)
Q. What are Index funds?
A. Index funds are a type of passive investment. In these funds, the fund managers allocate the assets in the same proportion as the index which he/she is trying to mirror. Along with mirroring the allocation, fund managers also try to replicate the returns of the index.
Q. Do index funds have an expense ratio?
A. Yes, like other funds, index funds also have an expense ratio or a fund management fee associated with them. But, the fees are comparatively less as compared with other mutual funds because these funds are not actively managed by the manager or the fund houses.
Q. How are index funds taxed?
A. Index funds are taxed like equity funds. Capital gains on units redeemed within the 12 months period are taxed as STCG of 15% and the units redeemed after the period of 12 months are taxed as LTCG of 10%. The LTCG on capital gains is taxed only on the gains which exceed Rs. 1 lakh per financial year.
Q. Who should invest in index funds?
A. As an individual investor, it requires high capital to copy an index. The investors who want to have index-like returns can consider investing in index funds as these funds replicate the performance of the market index and deliver similar returns as that of the index.
Q. Is index funds a good investment?
If you are looking for a long-term, cost-effective, and simple way to invest in the stock market, then yes it can be a great investment for you.
Q. Which is an index fund?
An index fund is a group of investments that mirrors the asset, weights, and performance of a well-known index like Nasdaq, NIFTY, S&P 500, etc.
Q. Which Indian index fund is best?
According to returns earned in recent times, a few index funds that you can check are - the HDFC Index Fund, Tata BSE Sensex Index Fund, HSBC Nifty 50 Index Fund, Motilal Oswal Nifty 50 Index Fund, etc.
Q. What are the big 3 index funds?
If you are talking about the "Big 3" investment funds in the USA, currently they are BlackRock, Vanguard, and State Street. They hold a major part of shares in, S&P 500 companies.
Q. Are index funds a type of passive investment?
A. Yes, Index funds are considered as a passive investment strategy. The fund managers do not actively manage these funds. They simply invest in the same securities and in the same proportions as in the index. These funds do not try to outperform the benchmark index rather they just aim to replicate the performance of the index and deliver similar returns.
Q. Which is the best index fund to invest in India?
There are various index funds available in the market to invest into. You should consider factors such as market-cap focus, expense ratio, tracking error, etc. while picking the best index funds in India for yourself. Depending on your investment capacity and other factors, you can pick the best investment plan.
Q. How much should I invest in index funds?
Index fund investments are considered to be a part of a diverse portfolio of investments. So, you can make your index fund investment according to your financial objectives with the fund. You can choose to invest via an SIP or lump-sum amount.
Q. Is the Nifty 50 index fund good?
Yes, the Nifty 50 index funds are ideal for the investors who are looking for a low-cost, diversified investment. Additionally, the Nifty 50 index funds are also a great option for the investors who are new to the stock market.
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