Money Basics · SIPs & mutual funds

Index funds

An index fund is a mutual fund that simply buys all the stocks in a market index, like the Nifty 50, in the same proportion as the index. No stock picking. No fund manager gut calls. Just the market.

Why this is powerful

Most actively managed mutual funds fail to beat their benchmark index over 10+ years. The SPIVA India Scorecard, published twice a year by S&P Dow Jones Indices, which runs the indices being measured, has repeatedly found the large majority of large-cap active funds underperforming their benchmark over 10-year windows. Recent 10-year readings sit near three-quarters; over 5 years the figure is closer to 90%.

If the average professional can't reliably beat the market, what chance does a casual investor have? The answer: buy the market instead of trying to beat it.

> Don't look for the needle. Buy the haystack. That is John Bogle's argument in a line; he founded Vanguard and built the first index fund for retail investors.

The math works

The Nifty 50 has delivered roughly 12% CAGR over the last 20 years. That is history, not a forecast. Past performance does not indicate future returns. What an index fund does promise is structural: you get the index's return minus the fund's expense ratio, and nothing else. An actively managed fund has to beat the index by its own, much larger fee every single year just to draw level.

0.1–0.2%Expense ratio of a good Nifty 50 index fund

1.5–2%Expense ratio of a typical actively managed fund

How to pick one

Index funds tracking the same index are close to interchangeable. They all hold the same 50 stocks in the same weights. So compare the three things that actually differ:

• Expense ratio. The 0.1–0.2% band above; two funds copying one index differ here before anywhere else
• Tracking error, how far the fund drifts from the index it is copying; lower is better
• Fund size and age. A bigger, longer-running fund is generally easier to get into and out of

The same idea runs on other benchmarks: the BSE Sensex (30 companies), the Nifty Next 50, the Nifty 500.

When active beats passive

The argument made for active management in mid-cap and small-cap is that smaller stocks are less researched, so a skilled manager has more room to find something mispriced. Worth knowing what the data says before you accept it: SPIVA's mid- and small-cap readings are less lopsided than large-cap, but the majority of active funds in those segments still underperform their benchmark over 10 years. The gap narrows. It does not flip.

Takeaway. Index funds buy the whole market cheaply. Most active funds underperform their benchmark over 10+ years, and the shortfall is widest in large-cap, which is where paying extra for active management is hardest to justify on the evidence.