Index Funds: Meaning, Advantages and Disadvantages (2024)

In this article, we will discuss

What are Index Funds?
What Are the Features of Index Funds?
How to Invest in Index Funds in India?
Advantages of Investing in Index Funds?
Disadvantages of Investing in Index Funds
Conclusion
FAQs

When it comes to investing in mutual funds, index funds are one of the most straightforward options available to investors. They have gained rapid popularity in these past few years among investors due to their consistent returns and ease of management.

In this blog, we will discuss the meaning of these funds, their pros and cons and how you can choose the right fund for you. Read on to know more!

What are Index Funds?

An index fund is a type of mutual fund that tries to replicate the performance of a specific index. It does so by investing in the same stocks that are part of a specific index in a proportion which is also similar to the index. The goal of the fund manager of these funds is to track the performance of the underlying benchmark and generate similar returns as per the growth of the index.

To better understand it, let’s take an example. Suppose there is an index fund that tracks the performance of Nifty 50. For those who are unaware, Nifty 50 is made up of the 50 biggest Indian companies in terms of market capitalisation.

Hence, an index fund that tracks the performance of Nifty 50 will also have stocks of these 50 companies in its investment portfolio. The fund manager’s primary goal would be to generate returns just like the Nifty 50.

What Are the Features of Index Funds?

Here are some key features of these funds:

How to Invest in Index Funds in India?

With these simple steps, you can easily start investing in index funds and thus begin your journey of passive investing.

Step 1: The first step to start investing in these funds is to choose an index that matches your investment goals.

Step 2: Research different index funds that track the performance of the index you chose. Make sure to check for any tracking errors or if the fund has any deviations from the original index.

Step 3: Choose if you want to invest directly through the website of the mutual fund or through a broker.

Step 4: Depending on your choice, open an account either on the official website of the mutual fund or the stockbroker you chose. You can choose the Samco New-Gen app to open an account and start investing.

Step 5: Fill in the necessary information and complete your KYC.

Advantages of Investing in Index Funds

Investing in these funds comes with a lot of advantages. Here are some of the major ones:

Since these are passively managed funds, they come with a lower expense ratio and other fees. This allows you to divert more capital towards the investment.
Investing directly in the stocks of an index can prove to be quite expensive. With index funds, you can track the index of your choice and reap similar returns without having to invest a big sum of money.
Since the asset allocation of the index fund is spread over all the stocks of an index, it adds an edge of diversification to your portfolio.
While all fund managers are highly knowledgeable and hold a lot of experience, a difference in opinion and judgement can impact the returns of the funds. Index funds eliminate this probability because the fund managers do not choose the stocks to be added to the portfolio.
Since these funds have very low volatility, they are an excellent choice for investors with lower risk tolerance.

Disadvantages of Investing in Index Funds

Here are some disadvantages of these funds that you must consider before investing in them.

If you are one of those investors who want to generate returns higher than the market, these funds are not the right investment choice for you. Rather, active investing will suit your goals better.
Since the performance of these funds depends on their underlying index, if the index dips, so will your investment.
Since it is a club of different stocks, you might be forced to invest indirectly in some stocks that you don’t want.

Conclusion

Index funds have, over time, often outperformed other actively managed funds and have successfully become a popular investment choice. However, they come with their own set of pros and cons that we have briefly discussed above.

If you wish to start investing in index funds or explore the stock market, open a trading account on the New Gen Samco Trading app today.

Frequently Asked Questions

Q1. How are index funds different from exchange-traded funds?

Ans. While they are quite similar, one major difference between these two funds is that the units of exchange-traded funds can be traded on stock exchanges, but the same is not applicable to index funds. Hence, you need a demat account for ETFs but not for index funds.

Q2. What are the factors to keep in mind while choosing an index fund?

Ans. An investor must consider their risk tolerance, investment goals, type of stocks they want to invest in and the expense ratio of the fund as well. Make sure to also find out any other charges the fund levies.

Q3. What is expense ratio?

Ans. This is the expense a fund incurs on its portfolio management, administration, and marketing of the fund. It is expressed in the percentage form and levied on investors to cover the cost.

Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING. The asset classes and securities quoted in the film are exemplary and are not recommendatory. SAMCO Securities Limited (Formerly known as Samruddhi Stock Brokers Limited): BSE: 935 | NSE: 12135 | MSEI- 31600 | SEBI Reg. No.: INZ000002535 | AMFI Reg. No. 120121 | Depository Participant: CDSL: IN-DP-CDSL-443-2008 CIN No.: U67120MH2004PLC146183 | SAMCO Commodities Limited (Formerly known as Samruddhi Tradecom India Limited) | MCX- 55190 | SEBI Reg. No.: INZ000013932 Registered Address: Samco Securities Limited, 1004 - A, 10th Floor, Naman Midtown - A Wing, Senapati Bapat Marg, Prabhadevi, Mumbai - 400 013, Maharashtra, India. For any complaints Email - grievances@samco.in Research Analysts -SEBI Reg.No.-INHO0O0005847

Tagged: Index Funds

Index Funds: Meaning, Advantages and Disadvantages (2024)

FAQs

What are index funds' advantages and disadvantages? ›

While they offer advantages like lower risk through diversification and long-term solid returns, index funds are also subject to market swings and lack the flexibility of active management.

What is an index fund in simple terms? ›

Index funds are investment funds that follow a benchmark index, such as the S&P 500 or the Nasdaq 100. When you put money in an index fund, that cash is then used to invest in all the companies that make up the particular index, which gives you a more diverse portfolio than if you were buying individual stocks.

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What is the main advantage of index funds? ›

There are also several advantages to index funds. The main advantage is, since they merely track stock indexes, they are passively managed. The fees on these index funds are low because there is no active management.

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Are index funds still a good investment? ›

Index funds offer low costs, broad diversification, and attractive returns, making them a good option for investors interested in a simple, low-cost investment. Rather than hand-selecting investments, index fund managers buy all (or a sample of) the securities in an underlying index.

What is index advantages and disadvantages? ›

Indexes have several advantages and disadvantages. One advantage is that they focus attention on key variables, making it easier to understand complex phenomena. However, indexes also have disadvantages. They can be highly abstract, making it necessary to study tangible, composite forms of innovation-related phenomena.

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What are the risks of index funds? ›

While index funds are generally less risky than actively managed funds, they can still be affected by market fluctuations. Consider your risk capacity when selecting an index. Tracking Error: Evaluate the fund's tracking error, which measures how closely the fund's returns match the index it's designed to replicate.

Should I put my money in an index fund? ›

Lower risk: Because they're diversified, investing in an index fund is lower risk than owning a few individual stocks. That doesn't mean you can't lose money or that they're as safe as a CD, for example, but the index will usually fluctuate a lot less than an individual stock.

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How do index funds make you money? ›

How do index funds work? Index funds don't try to beat the market, or earn higher returns compared to market averages. Instead, these funds try to be the market — by buying stocks of every firm listed on a market index to match the performance of the index as a whole.

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Should I buy stocks or index funds? ›

Index funds often have lower fees than the costs incurred when trading individual stocks. If you are hiring a registered investment advisor for investing in stock individually it may cost you much more than investing in an index fund.

Can index funds go broke? ›

All investments carry risk. An index fund, like anything else, can potentially lose value over time. That being said, most mainstream index funds are generally considered a conservative way to invest in equities (although there are lesser-known index funds that are thought to carry greater risk).

What happens to index funds when the market crashes? ›

For instance, in a major sell-off, when an index itself loses value, an index fund holding the underlying securities of the index will also lose value. However, investors who hold on to their fund investments should see the fund value increase as the value of the index itself reverses course and increases.

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Can you cash out index funds? ›

Capital gains taxes on that sale are yours and yours alone to pay. To get cash out of an index fund, you technically must redeem it from the fund manager, who will then have to sell securities to generate the cash to pay to you.

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Why use an index fund instead of a mutual fund? ›

The main difference is that index funds are passively managed, while most other mutual funds are actively managed, which changes the way they work and the amount of fees you'll pay.

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Should I keep my money in index funds? ›

Low-cost index funds are among the most advantageous investment vehicles for people focused on the long term. It's important to know a fund's expense ratio, which denotes how much money in management fees you'll pay before investing your hard-earned dollars.

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What is the average rate of return on index funds? ›

The average stock market return is about 10% per year, as measured by the S&P 500 index, but that 10% average rate is reduced by inflation. Investors can expect to lose purchasing power of 2% to 3% every year due to inflation. » Learn about purchasing power with the inflation calculator.

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