A few years ago, most Indian investors had never heard of index funds. Today, they're one of the fastest-growing parts of the mutual fund industry. Friends recommend them. Finance creators talk about them constantly. New ones launch every few months. So what's behind the boom? Are index funds really better, or just fashionable? Here's an honest look at why they've become so popular, what they do well, and where they fall short.
What an index fund actually does
An index fund simply copies a market index, like the Nifty 50. It holds the same companies in the same proportions. There's no fund manager trying to pick winners. When the index goes up, the fund goes up. When it falls, the fund falls. The goal isn't to beat the market. It's to match it, at low cost.
Our page on index funds explains the basics.
Reason 1: low costs
This is usually the first thing people notice. Because there's no team researching and picking stocks, index funds usually have much lower expense ratios than actively managed funds. Over many years, that cost difference compounds. Lower costs mean more of the market's return stays with you.
Our page on expense ratio explains why this matters.
Reason 2: many active funds struggle to beat the index
This is the big one. Over long periods, a meaningful share of actively managed large cap funds haven't beaten their benchmark index after costs. It's hard to consistently pick better stocks than the market, especially among large, widely researched companies.
When investors see that, a natural question follows: why pay more for a fund that may not beat a cheaper alternative? Our page on active versus passive funds explores this debate.
Reason 3: simplicity
It's easy to understand. With an index fund, you know exactly what you own. No surprises about the manager changing strategy, no worrying about whether a star manager leaves. That simplicity appeals to many people, especially beginners.
Reason 4: no manager risk
People matter. Active funds depend heavily on the person running them. A great manager can add value. A poor one can lag for years. Index funds remove that variable entirely.
Reason 5: more choices than ever
Indian investors can now choose index funds on the Nifty 50, Nifty Next 50, broader market indices, mid caps, small caps, and various factor and sector indices. That variety has helped the category grow.
Our page on how to invest in the Nifty 50 covers the most popular option.
Where index funds fall short
They're not perfect. It's worth being honest about the limits.
No protection in falls. When the market crashes, an index fund falls with it, fully. There's no manager to move to cash or defensive stocks.
Concentration. Market-value-weighted indices give big weight to the largest companies and sectors. If those struggle, the index feels it.
Mid and small caps are different. In smaller company segments, active managers have historically had a better chance of adding value, because those stocks are less researched. The case for indexing is strongest in large caps.
Tracking error. Index funds don't match the index perfectly. Costs and cash holdings create small gaps. Our page on tracking error explains this.
Not all index funds are equal
Several funds may track the same index, but they differ in cost, tracking accuracy and size. And some newer "smart beta" or thematic index funds are much less diversified than a broad market index. Read what each one actually tracks.
Our page on factor and smart beta funds explains these variations.
A common misunderstanding
Some people think index funds are "safer" than active funds. They aren't, in the sense most people mean. A Nifty 50 index fund holds large companies, so it's diversified, but it can still fall sharply in a bad year. Its risk is the market's risk. What it removes is the extra risk of a manager making poor choices, not the risk of the market itself.
Our page on risk and volatility explains the difference.
How to compare index funds
- Index tracked: make sure it's the one you want.
- Expense ratio: lower is better, for the same plan type.
- Tracking difference: how closely it followed the index.
- Fund size: larger funds often track better and cost less.
Past returns matter less here, because funds tracking the same index should produce nearly the same result. The differences come down to cost and accuracy.
Index funds and ETFs
ETFs also track indices but trade on the stock exchange. They need a demat account and are bought at live market prices. Index funds are simpler for SIPs and don't need demat. Our page on ETF versus index fund compares the two.
Should you choose index funds?
For many investors, especially for the large cap part of a portfolio, an index fund is a sensible, low-cost choice. Some investors build their whole equity allocation from index funds. Others combine an index fund core with a few active funds in categories where they believe active management helps.
Both approaches can work. What matters more is that you invest regularly, choose a sensible mix, and stay invested for many years.
Why the boom happened now
Timing helped. More young investors started investing through apps, where low-cost products stand out. Costs became easier to compare. Social media spread the message quickly. And several years of strong large cap markets made the simple "just own the market" idea look very attractive.
Will it last? Probably. Low costs and simplicity don't go out of fashion, even when markets turn rough, though some of the excitement may cool when the index has a bad year and people realise an index fund falls with the market, every single time, without exception, because that is exactly what it's designed to do.
The behaviour problem doesn't go away
Here's something people forget. An index fund can't protect you from your own reactions. If you panic and sell when the market falls, a low-cost index fund won't save you. The investors who benefit most from index funds are the ones who buy steadily and hold through bad years.
Our page on long-term investing explains why patience matters more than product choice.
Costs are only part of the story
A low expense ratio is great. But choosing the right category, investing regularly and staying the course will usually affect your results far more than the cost difference between two good funds. Don't let a tiny cost gap distract you from the bigger decisions.
A simple way to start
If you're new to investing, a monthly SIP in a broad index fund, alongside an emergency fund and a debt fund for short-term goals, is a perfectly reasonable starting point. You can always add more later.
Our page on how to start investing covers the first steps.
The bottom line
Index funds have become popular for good reasons: low costs, simplicity, and the difficulty many active funds face in beating the market over time. They aren't magic, and they won't protect you from market falls. But for a lot of investors, especially in the large cap space, they're a solid foundation.
If you'd like help deciding how index funds fit into your portfolio, I'm happy to talk it through. Myfolios is an AMFI-registered mutual fund distributor (ARN-145870) working from Indore since 2014. Get in touch.
