Before we dive in the Index funds. Lets just get the basics out of the way.

What is Index (not Index fund!) – Index is summation/ summary of what all is in the book.

Are there different type of Index – Yes, like the one which captures chapter of the book, other can be for specific type of topic/ themes or for the popular phrases used in the book and so on.

What is Index on Stock market and who makes the Index – Index can be of different types and these Index are made and maintained by the Stock exchanges (like NSE and BSE) on the basis of pre defined logics. Broadly the idea is any Index whether it is meant to represents the complete market or specific size of the company or the specific sector, should capture the essence of underlying companies which its is representing in-terms of growth potential, risk, earnings, cash flow etc..

Some of the example of the index, so that you can relate-

If you want to understand how to measure the performance of any assets – please refer here to understand Absolute return, IRR, CAGR – URL

As you can seem there are variety of Index from Broad market like Nifty 50 to Metal Index, depending on what you are looking for.

What is Index fund – Index fund is made to mirror on these index i.e. it will take money from investors and buy exactly the stock of same companies which are part of the index (conceptually, in reality most of these buy ETF, which we will cover in other post!) depending on which category you are targeting, example – Just Big companies in market or Small companies or Metal companies etc.

How does it works – Index funds work like Mutual funds (they indeed are Mutual funds with just passive management) i.e. it will collect the money from investors like you and me (mutual money/fund) and then invest in the companies.

How Index fund is created – Asset management companies (AMCs, like HDFC, AXIS, SBI etc.) will first decide which theme fund is required in the market, let say Next 50 upcoming stocks. Then, AMC will take money from investors like you and me, then will invest that money to the same companies which are part of NIFTY Next 50 Index.

Lets see some features of the Index fund, which should answer most of the questions which you may have –

1. Low cost – Fund manager invests the money in same set of shares which are part of NIFTY Next 50 index, so fund manager will not have do much of work to find companies, track companies etc. That is why the expenses which fund manager take from the fund before returns are given to investors, are pretty small. To be put things in perspective, expenses ratio of Index fund is 0.1% to 0.5% per year of the amount invested Vs 0.75% to 1.5% in the regular Mutual funds.
2. Investment size – You can invest in Index funds starting from as small as 500 rupees. To set things in perspective, if you were create Index by your self then you will have to buy 1 share of each 50 companies which NIFTY Next 50 index has, which will may cost you anywhere from 10s of Lakhs to few Crores. But, Index fund gives you an access to the same Index at low entry price which access and diversification to 50 stocks.
3. Passive Investment – This a type of passive investment. You just need to make up your mind that you want to invest in certain Index. Once you have decided, then you invest money and relax because Index fund manager will ensure that fund is always a mirror of the Index which you have chosen. So, almost no buying and selling of stocks either by your fund manager or you.
4. Suited for Long term investment – Given that Index fund mirror the chossen Index, so the prices will go up and down as the Index will move. The investor should have long term mind set when they invest in Index funds, so that Index has sufficient number of years for it to grow in value and also, as investor you have the flexibility to exit when the market is doing well (As an investor to ensure, you always make money you need to have right allocation of money, to understand more refer- https://financegrail.com/holy-grail-of-investing-asset-allocation/)

So, are these better than other type of stock market investments like investing directly in company stock or Mutual funds ?

It certainly has the cost advantage and a touch of professional fund manager. So, if you are ok with the Index theme and you are passive long term investor then it will be ideal to invest through Index funds then investing directly.

What are the top index funds available in market, what Index they are based on and how has been their performance in last 3 years?

HDFC Index Nifty 50 Fund – 12.5% PA

UTI Nifty Index fund – 12.7% PA

Nippon India Index Fund Sensex Plan 12.30% PA

Just google it!

How you can buy these and do you need to have demat account ?

You can buy these either directly from the website of the AMC which have launched these funds like HDFC, UTI etc, or you can also buy these from intermediators who facilitate the access to most of these AMC like Groww, Zerodha, Scripbox etc.

And, you do not need to have the demat account.

Before we finish this topic, lets just help you to visualize this with help of simple graphs-

If you would have invested 10,000 rupees 5 years back in the Nifty 50 Index fund, today it will be worth almost 20,000, without taking any judgement call and paying money to advisors etc.. Which is better than –

Fixed deposit

Good performing mutual funds like Axis Bluechip Mutual fund

Gold

As you can see, there is a strong merit in investing in Index funds if you are long term investors, instead of having the hassle of buy many many mutual funds, trying to manage portfolio by tracking them and progress, also paying them almost 1.5% of the vale of the mutual fund on a yearly basis so that they can try to out perform the market (which you can see they are not able to do!)

Now, can we say that every time Index funds are better than Mutual funds ?

In general , if you want to invest in big companies through mutual funds, then Index funds are the better option, rarely mutual funds have been able to outperform the Index funds (Index!).

But if you want to invest in Medium size companies or Small size companies through Mutual funds, then I would say Mutual funds are the better option, because good Medium and Small companies can outperform bad Medium and Small companies by a huge margin. Also, lot of skills and knowledge is required to pick right medium and small companies where Mutual fund manager skills come handy and they add value.

Before you start investing, be sure to understand all the available investment options, risks involved and suitability here – URL

Happy investing!