What Is an Index Fund and Should You Buy One?

Short answer: An index fund passively tracks a market index like the Nifty or Sensex, charging very low fees, and it is an excellent low-cost core holding for most long-term investors who do not want to pick winning active funds.

How It Works

Instead of a manager trying to beat the market, an index fund simply buys the same stocks as a chosen index in the same proportions. Its goal is to mirror the index's return, not exceed it. Because there is little active decision-making, costs are very low.

The Case for Index Funds

Many actively managed funds fail to beat their benchmark over the long run, especially after fees. An index fund sidesteps that problem by guaranteeing you roughly the market return at minimal cost. Low fees plus broad diversification make index funds a strong default for the core of a portfolio.

What You Give Up

An index fund will never beat the market — by design it tracks it, minus a small cost. In years when skilled active managers shine, you will trail them. You also ride the index all the way down in a crash, since there is no manager trying to cut losses. You accept market returns, good and bad.

Tracking Error and Choice

Not all index funds track perfectly; a small 'tracking error' shows how closely a fund follows its index. When choosing, prefer funds with low cost and low tracking error following a broad, well-known index, rather than an obscure or narrow one.

Who It Suits

Index funds suit beginners, busy investors, and anyone who wants simplicity and low cost without researching active managers. A common approach is to build the core of a long-term portfolio from broad index funds and add other funds only if you have conviction.

Sources: SEBI Investor Education

This explainer was written by The Dispatch desk to answer a question readers commonly ask. It is general information, not personalised financial advice.