Updated on March 18, 2023
Before understanding an Index Fund, it is important to know that a Mutual Fund’s performance is measured against its benchmark, which is an ‘Index’. An ‘Index’ consists of stocks or securities from a particular category, industry or is a general colletion of such securities. An Index is designed with a defined calculation methodology. S & P 500, BSE Sensex, Nifty 50 are some examples of an Index.
An ‘Index Fund’ is a fund which invests in such an ‘Index’. The Fund Manager of an Index Fund buys securities in a proportion similar to that of the target Index. This means that an Index fund is a replica of its benchmark Index.
What are the features of Index Fund?
Some features of an Index Fund are
a) It is a diversified fund where the Fund Manager’s only role is to select stocks as per their weightage in the Index
b) As it is a replica of the Index, performance of the fund would be similar to the returns from the Index
c) Index fund costs are very low
d) An Index Fund has the same risk as any other market related instrument, depending on the kind of assets it holds
What are the benefits of Index Funds?
Investors can avail the following benefits from index funds:
1. Index Fund safeguards an investor from choosing a bad advisor or wrong fund by giving returns equal to the benchmark.
2. The expense ratio for an Index Fund is low as compared to an actively managed diversified fund. The cost difference adds to the long term compounding.
3. Index Fund investing removes the biases of a Fund Manager