Best Index Funds
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About Index Mutual Funds
Index funds are funds that mirror an existing stock market index. They choose the same stocks and assign them the same weights as the index does to match the composition and the performance of the index as closely as possible.
Index funds fall under the category of passively managed funds because they require far less time and effort to operate than actively managed funds. The latter requires a careful asset selection process, market timing, risk management, and, thus, more operating costs. Very little control is required by the managers of index funds.
How do Index Funds work ?
An index fund is a type of diversified equity fund that operates differently from actively managed funds. In an index fund, there is no active involvement of a fund manager in selecting individual stocks. Instead, the fund aims to replicate the performance of a specific stock market index, mimicking both the choice of stocks and their respective weightings within the index.
This close correlation between the index and the index fund’s portfolio means that the Net Asset Value (NAV) of the fund closely mirrors the movements of the index it tracks.
For example, if the underlying index, such as the Sensex, increases by 10% in a month, the NAV of the Sensex-linked index fund will also roughly appreciate by approximately 10% during the same period. Conversely, if the Sensex declines by 10%, the NAV of the index fund will similarly decrease by about the same percentage.
Index funds are popular for their simplicity and the fact that they provide investors with a way to passively invest in the broader market’s performance.
Features of Index Funds
The following are some of the basic features of index funds:
- Lower costs – As discussed above, the fees are lower for index funds when compared to actively managed mutual funds.
- Risk and return – Indices generally gain in value over time, but the rate of return is lower than that of a more actively managed fund. In fact, beating the index performance is usually an objective of any actively managed fund.
- Tracking error – If the portfolio of an index fund is not a hundred percent the same as that of the index that it is trying to mirror, then the fund is said to have a tracking difference. It is an important feature that should be checked while assessing the fund. We will read more about tracking errors in a later section.
- Long term investment– If investors have a large chunk of their investment in index funds, then they must wait patiently for their investment returns to come. Indices may not increase every year and may see many downtrends in the short run.
Advantages of Investing in Index Funds
- Lower Expense Ratio – Since index funds are passive investments, the costs of operating and managing them are far lower than for an actively managed fund, whether debt or equity. Hence, their expense ratios and usual prices are also lower than actively managed funds.
- Less effort required – Because index funds are benchmarked, the investors do not have to worry about only a handful of stocks falling in price – the benchmarks generally tend to rise over time unless there is a structural change in the economy.
Due to the above reasons, index funds become especially better investment opportunities for retail investors who do not have enough time to keep track of investments but want a moderate return on their idle cash.
Risks involved in Index Funds
- Tracking difference and tracking error – Tracking difference is the difference between the performance of an Index Fund (in terms of its NAV) and that of the benchmark index being tracked by the fund. The variability in the tracking difference over some time is known as the tracking error. A fund with a high tracking error and regular negative tracking difference means that the fund is regularly failing to meet the performance of the benchmark index and is thus not good for investment.
- Economic downturn – Indices fall during a general economic downturn. Therefore, during such periods of negativity in the market, it is better to switch your holdings into either safe havens like gold or specific equities or commodities which are performing well.
Factors to Consider Before Investing in Index Funds
To develop a successful investment strategy when contemplating index fund investments, it’s crucial to bear in mind these key factors:
- Index Selection: Carefully choose the index that aligns with your investment goals. Common indexes include the S&P Sensex, Nifty Bank or the Nifty 50. Each index represents a different segment of the market, so select one that matches your objectives.
- Expense Ratio: Keep an eye on the fund’s expense ratio. Lower expenses translate to higher returns for investors. Index funds are known for their cost efficiency, so aim for minimal expense ratios.
- Diversification: Ensure that the index fund provides broad market exposure. A well-diversified index fund spreads risk across various sectors and stocks, reducing vulnerability to market fluctuations.
- Historical Performance: While past performance doesn’t guarantee future results, review how the index fund has tracked its benchmark over time. Consistency in tracking the index is a positive sign.
Who Should Invest in Index Funds?
Persons who have the following should definitely consider investing in index funds:
- Confidence in the future growth of the sector/economy that the index is tracking – Because an index performs well if the sector or the economy as a whole performs well.
- Lack of familiarity with the stock market – If the investor is new to the stock market, then index fund investments are a great way to start. Index funds follow the basic indices, which overall tend to grow with time. This allows the investor time to understand the stock market trends.
- Lack of time or inclination towards keeping track of funds too often – Investors can invest in the index fund and let the index guide the trajectory.
- Reluctance to pay excess fees – Since index funds charge a lower fee, the investor can take home more cash.
- Wish to diversify – That is, to turn their high-risk portfolio into a more balanced one.
Taxability of Index Funds
For tax purposes, index funds are considered the same as equity funds. They offer returns in the form of dividends and capital gains – both have taxes applicable to them.
Dividend taxation – The dividend income is added to the investor’s taxable income and taxed as per their slab. There is also a 10% TDS charged by the mutual fund house on a dividend amount exceeding ₹5,000 in a financial year.
Capital Taxation – Taxes on capital gains are imposed upon redemption. If redemption takes place after 1 year since the first investment, then only the amount of capital gains over and above ₹1 lakh is taxed at 10%. If redemption takes place within a year of the first investment, then a tax of 15% is imposed on the short-term capital gains.
How to invest in Index Funds ?
Investing in Index Funds is hassle-free through your Angel One account. You just have to follow these steps:
Step 1: Log in to your Angel One account using your registered mobile number. Validate the OTP and finally enter your MPIN.
Note: If you do not have a Demat account with Angel One, you can open one in a few minutes by fulfilling the KYC procedure and submitting the necessary documents.
Step 2: Determine the most-suited fund based on your needs and risk profile. You can evaluate each fund under the mutual fund section on the Angel One app. Things to consider at this stage are:
- Search for the fund you want to invest in or take cues from funds listed by Angel One across categories.
- Analyse the fund’s past performance, tax incidence, constituent sectors and stocks.
- Calculate the potential returns using the calculator.
- Evaluate the fund’s level of risk and weigh it against your risk tolerance.
- Check the fund’s ratings given by reputed rating agencies. Generally, the ratings range from 1 to 5.
- Consider the fund’s expense ratio to get an idea about the cost of investing in it.
Step 3: Once you finalise the fund(s) you want to invest in, open your Angel One account, go to the Mutual Funds section, and look for it. Since this can be a long-term investment, be careful when choosing the fund that you would like to invest in. At this stage, consider the following:
- Decide whether you want to invest in a lump sum or via monthly SIP
- Next, enter the amount you want to invest and choose how you want to make the payment. UPI is the preferred mode. Alternatively, you can choose net banking.
- After placing the order, in the case of the SIP route of investment, you can create a mandate to make hassle-free future instalments.
Top 5 Index Funds
| Name of the Fund | Assets Under Management (in Rs. crore) | Minimum Investment Amount (in Rs.) | 3Y CAGR (%) | 5Y CAGR (%) |
| HDFC Index Fund-S&P BSE Sensex Plan Direct Plan | 4,405 | 100 | 23.02 | 12.69 |
| ICICI Prudential S&P BSE Sensex Direct Plan IDCW Payout | 896 | 100 | 22.85 | 12.69 |
| Nippon India Index Fund-S&P BSE Sensex Plan | 400 | 5000 | 22.97 | 12.68 |
| Tata S&P BSE Sensex Index Fund Direct Plan | 214 | 5000 | 22.54 | 12.64 |
| LIC MF S&P BSE Sensex Index Fund Direct Plan Growth | 70 | 5000 | 22.69 | 12.48 |
The above-mentioned top funds are for informational purposes only and are not recommendations. The funds are based on a 3-yr CAGR, which is subject to change frequently. Check out real-time data on Angel One.
HDFC Index Fund-S&P BSE Sensex Plan Direct Plan
The fund has an expense ratio of 0.2%, and an exit load of 0.25% is the units are redeemed within 3 days from the date of allotment. The fund has been operating since January 2013 and has no lock-in period. It is a fairly concentrated fund, with its top holdings Reliance Industries, HDFC Bank and ICICI Bank occupying more than 30% of the total portfolio.
ICICI Prudential S&P BSE Sensex Direct Plan IDCW Payout
The fund has an expense ratio of 0.16% and no exit load or lock-in period. It is a fairly new fund established in September of 2017. Its top investments are also in Reliance Industries, HDFC Bank and ICICI Bank, which together make up more than 30% of the fund’s portfolio.
Nippon India Index Fund-S&P BSE Sensex Plan Direct Plan Growth
This fund has a low expense ratio of 0.15% and an exit load of 0.25% if the units are redeemed within 7 days of the date of allotment. The fund has been operating since January 2013 and has no lock-in period. It is also a fairly concentrated fund, with its top holdings also being Reliance Industries, HDFC Bank and ICICI Bank which are occupying more than 30% of the total portfolio.
Tata S&P BSE Sensex Index Fund Direct Plan
This fund has a low expense ratio of 0.27% and an exit load of 0.25% if the units are redeemed within 7 days of the date of allotment. The fund has been operating since January 2013 and has no lock-in period. It is also a fairly concentrated fund, with its top holdings also being Reliance Industries, HDFC Bank and ICICI Bank which are occupying more than 32% of the total portfolio.
LIC MF S&P BSE Sensex Index Fund Direct Plan Growth
The fund has been operating since January 2013 and has no lock-in period. It has a low expense ratio of 0.38% and an exit load of 0.25% if the units are redeemed within 7 days of the date of allotment. It is also a fairly concentrated fund, with its top holdings also being Reliance Industries, HDFC Bank and ICICI Bank, which are occupying roughly 30% of the total portfolio.
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