Index fund

An index fund buys the companies in an index in the same weights, so its return closely tracks that index. Nobody is picking stocks, so the expense ratio is usually far lower than an actively managed fund.

How it works

A market index, like the Nifty 50, is just a list of companies combined in set proportions. An index fund simply holds the same companies in the same weights and leaves them alone, rather than paying a manager to pick winners. When the index rises, the fund rises with it; when the index falls, so does the fund. There is no attempt to beat the market, only to match it cheaply.

Why low cost is the whole point

Because there is no research team and little trading, an index fund charges a fraction of what an active fund does. That matters enormously over time, because the fee compounds against you every year. A fund that charges 0.2% instead of 1.5% keeps far more of your return over decades. You give up the chance of beating the market and, in exchange, avoid the real risk of badly trailing it, which many active funds do after costs.

What to watch

An index fund still carries full market risk: it falls when the market falls, because it is designed to follow, not cushion. The main quality measure is tracking error, the small gap between the fund and the index it copies; lower is better. For beginners, a broad index fund is a low-cost, hands-off way to own equity. See active vs passive investing.