How to Invest in Index Funds in India

Index funds are a type of mutual fund that invests in the stocks of companies in a particular stock market index, such as the Nifty 50 or BSE Sensex. 

Index funds aim to replicate the performance of the underlying index by investing in all the stocks in that index in the same proportion as they are represented in the index. 

For example, the top 10 companies with their respective weightages are

Company	Sector	Weightage
Reliance Industries Ltd	Oil, Gas & Consumable Fuels	10.34%
HDFC Bank Ltd	Financial Services	9.31%
ICICI Bank Ltd	Financial Services	8.04%
Infosys Ltd.	Information Technology	6.68%
Housing Development Finance Corporation Limited	Financial Services	6.24%
ITC Ltd	FMCG	4.44%
Tata Consultancy Services Ltd	Information Technology	4.31%
Larsen & Toubro Ltd	Construction	3.43
Kotak Mahindra Bank Ltd	Financial Services	3.34%
Axis Bank Ltd	Financial Services	3.08%

These top 10 stocks represent almost 56% of the total weightage of Nifty 50. The other 40 stocks also have their respective weightage, but their contribution to the index is relatively less.

A nifty 50 Index fund invests in the same shares in the given proportion as that nifty 50. This approach makes index funds low-cost, and highly diversified investment options.

Tata Nifty 50 index fund invests in a similar ratio to Nifty 50 stocks. 

Some of the common indexes include 

• Nifty Bank index
• Nifty Midcap 100
• Nifty 100
• Nifty Smallcap
• Nifty 500 

Types of Index Funds in India

There are several types of index funds available to Indian investors, each with its unique characteristics and benefits. The following are the most common types of index funds available in India:

#1. Equity Index Funds

Equity index funds invest in the stocks of companies listed on a particular stock market’s index, such as the BSE Sensex or the Nifty 50. Equity index funds are a low-cost way to invest in the stock market, as they have low expense ratios compared to actively managed funds.

You can also read How to Invest in Nifty 50 article to understand other ways to invest in the Nifty 50 index.

#2. Debt Index Funds

Debt index funds invest in a portfolio of fixed-income securities such as bonds, debentures, and other debt instruments that track a particular debt index. Debt index funds are a low-risk investment option for investors who are looking for stable returns with minimal risk.

#3. International Index Funds

International index funds invest in stocks listed on international stock exchanges such as the Nasdaq, Dow Jones, and the FTSE 100. International index funds provide Indian investors with exposure to international markets and enable them to diversify their portfolios geographically.

Benefits of Index Fund Investment

#1. Low Costs

Index funds have low expense ratios compared to actively managed funds, as they do not require active management. You can save 2% -3% considerable amount of money in fees and charges over time.

#2. Diversification

Index funds provide investors with a diversified portfolio of stocks or fixed-income securities. This diversification helps to minimize risk and optimize returns over the long term.

#3. Passive Management

Index funds are passively managed, which means that there is no need for an investment manager to actively buy and sell securities. This approach reduces the overall cost of the fund and ensures that the investment performance is not impacted by the biases or decisions of the fund manager.

#4. Consistent Performance

Index funds have a history of delivering consistent performance over the long term. As index funds are designed to replicate the performance of the underlying index, they tend to perform in line with broader market trends.

#5. Suitable for Beginners

Index funds are an excellent investment option for beginners who do not have much experience in investing in the stock market. As index funds are low-risk, low-cost, and highly diversified, they provide an easy and convenient way for beginners to invest in the stock market.

How to Compare an Index Fund

Factors to consider when choosing an index fund to invest in are –

1. Expense Ratio – Opt for funds with a low expense ratio to reduce fees and potentially enhance returns.
2. Tracking Error – Assess the fund’s tracking error to determine how closely it tracks the underlying index. A lower tracking error is generally considered preferable.
3. Fund Size – Invest in funds with adequate assets under management (AUM) to ensure that the fund is well-established and has adequate resources to manage its investments effectively.
4. Fund House – Examine the reputation and track record of the fund house that offers the fund to gain insights into its management style and approach.

Reputed mutual fund houses in India are –

• LIC mutual fund
• ICICI Prudential mutual fund
• SBI mutual fund
• HDFC mutual fund
• UTI mutual fund

Top 10 Index Funds in India 2023

Based on the returns here are the top 10 Index funds in India 

Best Index Funds	Last 5-year Annualized Returns	Last 1-Year Return
Tata Nifty 50 Index Fund -Direct Plan	12.23%	-0.681%
UTI Nifty 50 Index Fund – Growth Option- Direct	12.22%	-0.812%
Nippon India Index Fund – Nifty 50 Plan – Direct Plan Growth Plan – Growth Option	12.13%	-0.816%
ICICI Prudential Nifty 50 Index Fund – Direct Plan Cumulative Option	12.13%	-0.819%
LIC MF Nifty 50 Index Fund-Direct Plan-Growth	12.05%	-1.066
Taurus Nifty 50 Index Fund – Direct Plan-Growth	12.02%	-0.827%
IDBI NIFTY 50 Index Fund Growth	12.01%	-0.919%
Taurus Nifty 50 Index Fund – Direct Plan – Growth	11.98%	-0.405%
LIC MF Nifty 50 Index Fund-Direct Plan-Growt	11.93%	-0.702%
HDFC Index Fund-NIFTY 50 Plan – Growth Plan	11.92%	-1.037%

Disclaimer – it is essential to remember that past performance is not a guarantee of future results. 

You can check the article on best index funds in India for more details like expense ratio, and minimum investment amount. 

Step-by-Step Process to Invest in Index Funds in India

Step 1 – Choose an Investment Platform

You need an account with a stock broker or mutual fund investment platform. Some popular platforms are

• Zerodha Coin
• Groww
• Scripbox
• FundsIndia
• Indmoney

You can invest through your existing Zerodha Demat account. If you want to open an account then you can learn step by step process to open Zerodha account. 

If you already have a demat & trading account with other brokers, then check if he offers investment in index funds or not.

Step 2 –  Search the Index fund 

After login, search for the index fund that you want to invest

You can check the details like fund past performance, compare return with market return, expense ratio, and exit load. 

Step 3 – Place Order 

You can invest a lump sum amount or you can start a SIP for index funds. For a lumpsum investment, you only need to mention the investment amount. 

For SIP, provide the details regarding 

• Initial Investment
• Installment amount 
• Frequency like monthly, weekly, or quarterly  
• Date for installment

Click on ‘start SIP’ to place the order.

How to Invest in Index Funds on Zerodha

You can invest in Index funds through Zerodha coin. Here are the steps 

Step 1 – Login into your coin.zerodha.com portal

Step 2 –either select ‘index fund category’ and search for the index fund that you want to invest in. 

Or directly search the index fund name in the top search bar.

Step 3 – Click on ‘Buy’ for a one-time investment or click on SIP options for regular investment 

Step 4 – Enter the lump sum amount that you want to invest.

In the case of SIP enter the details like 

• Initial Investment
• Installment amount 
• Frequency like monthly, weekly, or quarterly  
• Date for installment 

Step 5 – Make payment in case of lumpsum investment or click on Create SIP.  

Now you have to approve the e-Mandate to authorize your bank to make regular investments in your above-mentioned SIP. You can also read our dedicated article on how to invest in mutual funds using Zerodha coin.

Drawbacks of Index Funds

#1. Risk of Tracking Error

Index funds are designed to track a particular index. However, there is a risk of tracking error, which is the degree to which the index fund fails to track the index accurately. Tracking error poses a significant risk in index funds since index share weight changes and corporate actions can cause deviations from the index.

#2. Lack of Flexibility for Fund Managers

Index funds are required to maintain full investment in the index at all times, which limits the fund manager’s flexibility. While this rigidity can be advantageous during stable market conditions, or it can be problematic during extreme market upsides and downsides. For example, if the equity fund manager perceives the market to be excessively volatile, increasing the cash allocation can be beneficial. However, an index fund cannot take such a course of action.

#3. Potential Underperformance of Index Funds

While active funds have the potential to generate returns beyond their benchmark by taking additional risk, index funds merely replicate the underlying benchmark and are low-risk investments. As a result, investors who desire returns that exceed the benchmark index should avoid index funds.

#4. No Control over Holdings

You do not have control over the individual holdings in the funds. This means that you cannot exclude or include specific stocks or sectors from their portfolio.

Tax Implications on Index Funds

I. Short-term Capital Gains Tax

If you sell your index fund units within one year of purchase, you will be subject to short-term capital gains tax. Short-term capital gains are taxed as per your normal slab rate.

II. Long-term Capital Gains Tax

If you sell your index fund units after one year of purchase, you will be subject to long-term capital gains tax. The long-term capital gains tax is currently 10% of the gains above Rs. 1 lakh.

Conclusion

Index funds are good options for beginners who want to invest in a diversified portfolio of stocks but don’t have time or knowledge for stock analysis. 

You can expect the same return as the underlying index. But if you want to outperform the index return then you should invest in direct equity. 

Direct equity carries higher risk as compared to index funds with higher return rewards. You can choose the right investment based on your risk appetite, and return goals.  

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