What is Index Fund? Definition of Index Fund, Index Fund Meaning - The Economic Times (2024)

Index fund
An index fund is a fund which tracks the performance of an underlying index, like the Nifty or the Sensex. These funds stick to their benchmark index regardless of what happens in the market. Index funds are known for providing diversified exposure with lower management costs.

Index funds are generally seen as good core holdings for retirement plans. Warren Buffett, a famous investor, says that index funds are a safe way to save for retirement. He says that instead of picking specific stocks to invest in, it makes more sense for the average investor to buy an index fund that gives them access to all S&P 500 companies at a low price.

The Way Index Funds Work
Indexing is a passive way to manage your investments. Instead of picking stocks to invest in and planning when to buy and sell them, a fund portfolio manager builds a portfolio whose holdings match those of an index. The idea is that if the fund mimics the profile of the index—either the whole stock market or a large part of it—its performance will be the same as that of the index.

For the vast majority of financial markets, both an index and a fund follow that index. The S&P 500 is the most popular index fund in the United States. But a lot of people also use other indexes, like:

• The biggest stock market index in the United States is the Wilshire 5000 Total Market Index.
• The stocks that make up the MSCI EAFE Index come from Europe, Australia, and the Far East.
• The Bloomberg U.S. Aggregate Bond Index keeps track of the bond market.
• 3,000 stocks are traded on the Nasdaq that makes up the Nasdaq Composite Index.
• The 30 companies that make up the Dow Jones Industrial Average have a lot of money (DJIA).

For example, an index fund that tracks the DJIA would invest in the same 30 big, publicly traded companies that make up the DJIA.

Weighting is a way to make a single position in an index or portfolio less important. If the fund is trying to match a weighted index, its managers may change the proportions of different securities from time to time to match the weights of the index. Only when their respective benchmark indices change do the portfolios of index funds change significantly.

Index Funds as Compared to Actively Managed Funds
Passive investing is one way to look at investing in index funds. The opposite of passive investing is active investing, which is what actively managed mutual funds with a portfolio of securities and market timing do.

Reduced costs
The lower management expense ratio is one of the main reasons why index funds are better than actively managed funds. The expenditure ratio of a mutual fund, also called the management expense ratio, includes all of the fund's operating costs, such as the pay of its advisers and managers, transaction fees, taxes, and accounting fees.

Since index fund managers just copy the performance of a benchmark index, they don't need the help of research analysts and other people who help choose stocks. The fewer managers of index funds change their holdings, the less they have to pay in transaction fees and commissions. On the other hand, actively managed funds have bigger staffs and more transactions, which raises the cost of doing business.

The expense ratio shows how much more it costs to run a fund and passes those costs on to investors. So, inexpensive index funds usually cost less than 1 percent, usually between 0.2 percent and 0.5 percent, and some companies offer expense ratios of 0.05 percent or less. On the other hand, Actively managed funds charge much higher fees, usually between 1 percent and 2.5 percent.

ETFs are exchange-traded index funds. How do they work?
Exchange-traded funds can be set up as index mutual funds (ETFs). These products are stock portfolios that professionals manage. Each share is a small piece of ownership in the portfolio. The goal of index funds is not to beat the performance of the index they track but to match it. If, for example, a certain stock makes up 1% of the index, the company managing the index fund will try to match this by putting 1% of its portfolio in that stock.

Should you invest in an index fund?
Index funds have been considered one of the best ways to invest for a long time. Index funds are cheap, let you spread your investments out, and tend to give you high returns over time. In the past, index funds have done better than other types of funds that top investment firms actively managed.

What is an index fund for India?
Index funds are investments that follow an index. Their main goal is to make a portfolio that looks like an index of the stock market. A fund that tracks an index holds the same stocks in the same amounts as the index. Indian index funds are based on gold, Nifty, Midcap index, etc.

What are indexes and ETFs?
ETFs can be traded at any time during the trading day, while index funds can only be traded at the end. ETFs may also have lower minimum investments and be less tax-intensive than most index funds.

Is the index fund risky?
Index funds have the same level of safety as the index they follow. As you've seen, index funds show the volatility of the market right away. So, these funds are as safe as the market as a whole. It is a way to invest in immediate markets, not managed and spread out.

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