Index Funds

Index funds are mutual funds that replicate (or track) any market index. They take a particular index (like NIFTY or Sensex) as a base and fill the fund with the same stocks/bonds.

For example, if a mutual fund follows the NIFTY 50 index, the fund manager will invest at least 95% of the funds in the stocks already in this index.

The sole purpose of index investment funds is to copy-paste the exact stocks/bonds in a mutual fund. Therefore, if the underlying index is performing well, the stocks within the MF will likely perform similarly. However, here, the fund manager will act passively – meaning, once allotted, they won't change the fund's composition.

Index Investment Funds may sound synonymous with equity funds, but they fall in a different category. Like other mutual funds, these funds pool money from investors and allocate it (at least 95%) as per the underlying index chosen. Here, the fund manager has no active role in asset allocation, which means they will simply replicate/mimic the stocks/bonds as per the index composition.

For instance, if an index fund follows the Sensex 50 or the Gilt index, the securities within it will be the same as those in the index. However, if the index sees some stock additions/replacements, the fund manager will also make similar changes to the portfolio. They may buy or sell the units to align the fund's weight with the index.

This entire process enables passive management, where the fund manager may not always actively modify the portfolio. Therefore, you may find a lower expense ratio as a result of reduced cost structures and operational costs. But, due to this tracking error, the fund may not produce returns similar to those of an index.

Index mutual funds are closely associated with an index. Hence, if you want a portfolio that mimics an index, this fund is for you and;

• Individuals who prefer no human intervention opt for a more passive management approach.
• Someone who wants to follow the market indices or attend a similar level of yield.
• For those cost-conscious investors aiming for lower expense ratios, index investment funds can be a suitable match.

Looking to invest in index mutual funds online?

With Anand Rathi, you can explore and invest in index mutual funds through a secure, paperless, and easy-to-use platform.

Here's how you can get started in 5 simple steps:

Visit the Anand Rathi website or download the AR Invest app to open a demat account or log in securely.

Enter the required details and finish the quick, paperless KYC process in just a few minutes.

Browse and compare the range of index mutual funds available, supported by research insights and fund ratings.

Select a fund that suits your goals, decide the investment amount, and invest via SIP or lump sum.

Easily track performance, NAV (Net Asset Value), asset allocation, and portfolio updates—all in one place.

Finding an index fund for your portfolio among 1300+ MFs can be challenging. As an investor, you should consider these pointers, which include:

• Investment horizon and goals - On an observational note, it is seen that index funds do fluctuate in the short-term but average out in the longer run (more than 7 years). So, if you intend to stay invested for a longer period, these funds can suit you.
• Tracking error - Even though the name suggests index mimicking, the fund can still show tracking error. The fund manager may be consistent with the tracking, but a small gap for error does exist, which means the index level returns may not always match the fund's yield.
• Risk appetite - Indices have a feature of positive growth and negative as well. So, if the market underperforms, your portfolio will also behave the same. Hence, before investing, consider your risk tolerance level in such volatile times.
• Fund Size & Liquidity - Larger funds generally offer better liquidity and lower tracking errors, but extremely large funds can become less flexible.

The taxation of index funds will depend on their nature; i.e., equity-oriented or debt-oriented.

If the fund follows an equity index (like NIFTY or Sensex) -

For debt-oriented index funds, STCG applies, and you're taxed as per the individual slab rate, irrespective of holding period.

• Short-term capital gains (STCG) are taxable at 20%.
• For units held for more than 12 months, an exemption of ₹1.25 lakh is allowed on gains. Anything above this deduction will attract an LTCG of 12.5% on index equity fund.