Best Index Funds

When you invest in an index fund, the fund manager of that index fund uses your money to invest in stocks in the same proportion as the index that he is tracking.

For example, a NIFTY Index Fund invests in stocks of companies comprising the NIFTY 50 Index in the same proportion and aims to achieve a return equivalent to the NIFTY 50 Index. For example, as Reliance has a 10.3% stake in the NIFTY 50, the fund manager of a NIFTY Index Fund will build a portfolio where the weightage of stocks of Reliance company will be 10.3%. Similarly, stocks of other companies will be held in equal proportion as the index.

If a stock's weightage has increased or decreased in the index, the fund manager of an Index Fund will also replicate those changes in his fund. If a stock is removed from the index and new stock is added in its place, the fund manager of the Index Fund will sell all his holdings in the stock that has been removed and buy the new stock in the same proportion as it is in the index.

Since these funds don't have a team to manage them and they don't buy and sell stocks actively, their cost structures are really low. As a result, index funds are the cheapest mutual funds you can invest in.

Passively managed index funds can be useful for investors who want to keep their equity investment simple or those who do not want to select top-performing fund managers, etc. Here is a list.

• Investors Who Don't Want to Track Performance Continuously: When you invest in actively managed funds, you need to keep a track of the fund's performance. The fund might fall more than the markets or its category average in a crash. The fund might not even give market-level returns due to poor investment decisions. All these necessitate periodic review and tracking of fund performance.
  Index Funds remove this need. The fund portfolio and performance are all linked to a specific index. So investors can and then forget.
• Investors Who Are Happy With Market Level Return:As an investor, if you are happy with the returns offered by the market and do not want to take any extra risk for the possibility of earning higher returns, Index Funds are suitable for you. As these funds replicate the market Index, the returns generated by them are what the Index is generating. And since indices are really representative of the market, the returns are what is called market-level.
• Investors Who Want To Eliminate Human Bias: When you have a person making decisions about where to invest money, there are bound to be biases. The Fund Manager will have his own beliefs and convictions and while he will make informed decisions, there is always a possibility that biases kick in.
  Index Funds remove human bias from investment decisions completely. The indices are built based on certain rules and the Fund Manager just replicates the index. So if you as an investor want to have zero-bias investing, you can go for Index Funds

Index Funds have grown in popularity in India as they offer a number of benefits over more traditional actively managed funds. While a significant number of investors still invest primarily in actively managed funds as they have the capability of providing higher returns than the benchmark index, the following are 3 key reasons why Index Funds in India are gaining popularity:

No Fund Manager Bias

In the case of an Index Fund, the fund manager only replicates the index that is being tracked, so, there is no bias with respect to stock selection in this case. For example, an Index Fund tracking the NIFTY Next 50 Index will only invest in the 50 stocks that comprise the Next 50 Index. Moreover, the individual weight of each stock in the Index mutual Fund will be the exact same as their proportion in the NIFTY Next 50 Index. As the fund manager does not have to select and invest in stocks by himself/herself or have to time entry and exit into individual stocks, there is no risk of personal bias.

Low Cost of Investment

Managing even the best Index Fund does not require a team of analysts to research best possible investments or determine market trends to determine the ideal time of entry and exit into individual stocks. Thus, the cost of managing an Index Fund is significantly lower than that of an actively managed Equity Mutual Fund. Moreover, even the top index funds in India do not have engage in active trading, which reduces portfolio churn and leads to a lower expense ratio of the Index Funds compared to an actively managed scheme.

Diversified Investments

Indices typically comprise a basket of stocks that are diversified across multiple sectors and there are also limits to the exposure to individual stocks that an index can have. As the portfolio of an Index mutual Fund replicates the chosen index in every respect, these schemes offer investors diversified investments across multiple sectors and minimal concentration risk. Actively managed funds are often not able to deliver such a high degree of portfolio diversification at such low costs.