How to Invest in Index Funds in India

Index funds are mutual funds designed to track a specific market index. Instead of a fund manager actively selecting stocks, these funds replicate the composition of an index—such as the Nifty 50 or the BSE Sensex—by investing in the same constituent securities in broadly similar weightages. The objective is to mirror the performance of the index, and by extension, the relevant market segment, subject to tracking error, which is the difference between the fund's returns and the index returns due to expenses and other factors.

When changes occur in the underlying index, the fund portfolio is adjusted accordingly. If the index composition remains unchanged, the portfolio also remains largely unchanged. This rules-based structure keeps the investment approach relatively straightforward, which may be suitable for investors looking for long-term market-linked exposure without active decision-making.

Table of contents

• Understanding the basics: Passive investing explained by Bajaj Finserv AMC
• Key advantages: Low cost, diversification, and market returns
• Types of index funds available for Indian investors
• How to invest in index funds: A step-by-step guide
• Factors to consider before investing in index funds
• Monitoring your index fund investments

Understanding the basics: Passive investing explained by Bajaj Finserv AMC

Passive investing is an approach that aims to capture broad market performance over time by tracking an index, rather than attempting to outperform the market through active security selection. An index fund does this by buying securities in proportions similar to the index to maintain alignment.

Investing in an index fund provides exposure aligned with the movement of the underlying market index. As the index rises or falls, the value of the investment may move in a similar direction, subject to tracking differences and fund expenses.

This approach typically involves fewer portfolio changes compared to actively managed funds, which may lead to lower portfolio turnover and, in turn, relatively lower operating costs.

Key advantages: Low cost, diversification, and market returns

• Low expense ratio: Index funds typically have lower expense ratios compared to actively managed funds, as portfolio management decisions are rules-based and involve fewer discretionary transactions.
• Immediate diversification: A broad market index fund holds securities in line with the underlying index, either fully or through representative sampling. This provides exposure across multiple companies, sectors, or market segments, depending on the index being tracked.
• Market returns: The objective of an index fund is to closely track the performance of its benchmark index (subject to tracking error) rather than outperform it. As a result, returns may broadly reflect market movements over time, both during rising and falling phases.

Also Read: Large cap funds vs. index funds: Which is more suitable?

Types of index funds available for Indian investors

• Broad market index Funds: Track equity market indices such as the Nifty 50, BSE Sensex, Nifty Next 50, Nifty Midcap150, etc.
• Sectoral and thematic indices: They track sector/theme-based indices and may be more concentrated than broad based indices.
• Factor or strategy indices: Also called smart beta, these indices focus on certain factors or stock characteristics such as value, low volatility, quality, momentum, or equal-weight variants, where available
• Debt index funds: Some index funds track debt market indices, such as government or corporate bond indices.

How to invest in index funds: A step-by-step guide

The following steps outline how investors may approach investing in index funds in India:

Step 1: Define your financial goals and risk appetite: Investors may begin by identifying their financial objectives, such as long-term wealth creation, retirement planning, or other time-bound goals. Assessing the investment horizon and tolerance for market fluctuations may help determine the suitability of equity-oriented index funds, which are classified as high risk.

Step 2: Choose the mode of access: Index mutual funds may be invested in directly through an asset management company or via authorised distributors.

Step 3: Research and choose a suitable index fund: Investors may review factors such as the benchmark index, tracking difference, expense ratio, fund size, and liquidity. These parameters may provide insight into how efficiently a fund tracks its underlying index, though they do not predict future performance. Past performance may or may not be sustained in future.

Step 4: Decide on investment mode: Investments may be made through a lumpsum transaction or through a systematic investment plan, where a fixed amount is invested at regular intervals. Each method has different implications depending on market conditions, cash flow patterns, and investment horizon.

Step 5: Execute your investment: Once the chosen index fund aligns with the investor’s objectives and risk profile, the investment may be executed through the AMC’s platform or an authorised channel. Units are allotted based on the applicable net asset value, in accordance with SEBI cut-off timing guidelines.

Bajaj Finserv AMC also offers index funds, which you can invest in through the official website. Click here to view our index funds.

Factors to consider before investing in index funds

Before investing, investors may consider the following aspects, as they influence how index funds may function within a portfolio:

• Expense ratio and tracking difference
• Personal risk tolerance and investment horizon
• Tax implications based on fund category and holding period
• The role of index funds within the broader financial plan

Monitoring your index fund investments

Periodic portfolio reviews, such as on a quarterly or half-yearly basis, may help investors assess whether their investments remain aligned with long-term objectives. Frequent changes are generally not required for index-based investing, which is designed for longer-term participation in market movements.

Also Read: Index Funds vs Flexi Cap Funds: How are they different?

Conclusion

Index funds offer a structured way to participate in market movements through a passive investment approach. By understanding how index funds work and following a step-by-step investment process, investors may incorporate them into a broader financial plan focused on potential wealth creation over time. As with all market-linked investments, outcomes depend on market conditions, time horizon, and individual decisions.

FAQs

Are index funds suitable for beginners?

Index funds may be suitable for investors who are new to mutual funds and prefer a rules-based approach that tracks a broad market index, while being comfortable with market-related risks.

What is the minimum investment required for index funds in India?

Minimum investment amounts vary by scheme. Many mutual funds allow investments with relatively small amounts, including systematic investment plans with modest per-interval contributions.

Do index funds provide IDCW payouts?

Index funds may offer Income Distribution cum Capital Withdrawal (IDCW) options, depending on the scheme structure and the fund house’s offering. However, IDCW payouts are not guaranteed and are subject to the availability of distributable surplus and regulatory conditions. The amount and frequency of IDCW, if declared, depend on factors such as market performance, realised gains, and the scheme’s distribution policy.

How are index funds taxed in India?

Taxation depends on whether the index fund is equity-oriented or debt-oriented and on the holding period, as per prevailing income tax regulations. Tax provisions are subject to change, and investors may consult a tax professional for updated guidance.

Can I switch from an actively managed fund to an index fund?

Yes, it may be possible to switch from an actively managed fund to an index fund within the same AMC, subject to the fund house’s policies and applicable terms. Such switches are treated as a redemption from the source scheme and a fresh investment into the target scheme. As a result, these transactions may have tax implications and, where applicable, exit loads.

Do index funds have lock-in periods?

Index mutual funds do not typically have lock-in periods. Investors are advised to review the scheme documents for the exact terms.