If you are just starting out your investment journey, or are someone who has been investing for years now, chances are that you have come across the term Index Mutual Funds or Index Funds as they are popularly called.
Over the past few years, Index Mutual funds in India have moved from being a niche option for selective investors to becoming one of the most popular choices for beginner and seasoned investors.
But what is the reason behind their popularity? How do they really work? And should you consider Index Mutual Funds in 2025? In this article, we give you the complete guide to Index Mutual Funds in India.
Quick Summary:
- What & Why: Index Funds = passive, low-cost funds that mirror a market index (e.g., Nifty 50). Great for simple, diversified exposure. 🪙🧺
- Who it helps: Ideal for beginners building a core portfolio and pros seeking stable, low-fee market returns. âś…
- How to choose: Pick your benchmark first → compare funds on Tracking Error (lower better), Information Ratio (higher/closer to 0 better for indexers), and Expense Ratio (lower better). 🧮
- What to expect: You’ll match the market, not beat it; long-term discipline > stock-picking. ⏳
- Taxes (India): Equity index funds – STCG 20% (<1yr), LTCG 12.5% (≥1yr) with â‚ą1.25L annual exemption; debt index funds taxed at slab rates. 🧾
- Bottom line: A reliable, low-cost path to participate in India’s growth—start with a broad index, keep costs low, stay consistent.
What are Index Funds?
Index Funds at its core are a type of Mutual Fund that try to replicate the performance of their underlying benchmark index. The index can be an equity index or any other asset class index. For example, if you invest in a Nifty 50 Index Fund, the fund tries to replicate the performance of its benchmark: Nifty 50.
When the Nifty 50 Index goes up, the index fund value will go up. When the Nifty 50 Index falls, so will your index fund. Think of Index Funds as executing a copy-paste strategy. Instead of the fund manager actively choosing stocks, the fund passively mirrors the index.
Before we deep dive, let us understand Passive Investing.
What is Passive Investing?
Passive Investing is a form of investing that does not seek to earn returns by investing in securities different from that of their underlying asset. Active Investing focuses on selecting investment opportunities after researching and analysing investment options to generate returns and outperforming their underlying benchmarks.
Passive investing, on the other hand focuses to replicate their underlying benchmarks by positioning itself in similar securities and in the same proportion.
Passive investing is based on the belief that over the long run, it is very hard for most investors to consistently beat the market after accounting for costs in researching, analysing, and managing active investments. So why not just track the asset at lower cost by simply replicating it?
Index Funds follow the principle of Passive Investing. This means they don’t try to beat the market, instead, they aim to be the market.
Here is a quick comparison to help you understand Index Funds vs Active Funds
| Feature | Index Funds | Active Funds |
| Stock Selection | Replicates Index | Made by the Fund Manager and Analyst Team |
| Objective | Match the Index Return | Beat the Index Return |
| Costs (Expense Ratio) | Very Low | Relatively High |
| Importance of Manager’s Skill | Minimal | High |
| Returns | Close to Benchmark Index | Higher or Lower; depending on stock selection |
Why Index Fundsr can be a Great Starting Point for Beginners
- Simplicity: You do not need to have deep market knowledge to begin investing
- Low Cost: Passive Investing is not costly. Lower cost means, higher net returns.
- No dependency on Manager Skill: Passive Investing eliminates active selection, thereby reducing dependency on manager’s skill to generate returns.
- Diversification: Index Funds invest across stocks/securities, allowing beginner investors to invest across companies and sectors.
Evaluating Index Funds: How to Choose the Best Index Fund?
Index Funds are not all same; even if they have the same underlying benchmark. Therefore, it becomes essential to understand how to evaluate them before you invest in them.
Research the Benchmark Index first
It is important that you understand the underlying benchmark index first before investing in any Index Fund. Because that is what the Index Fund will replicate. Benchmark indices in India are available across asset class.
For example, equity indices like Nifty 50, Nifty 100, Sensex, Sensex 50, Nifty Bank, etc. Debt indices like Nifty 10 Year Benchmark G-Sec Index, Nifty Composite G-Sec Index, etc. Hybrid indices like Nifty50 Hybrid Composite Debt 70:30 Index etc.
Choose an underlying index based on your investment horizon, investment objective, and your risk profile.
Choosing the Right Index Fund
Once you have decided the underlying benchmark index to track, the next step comes to evaluate the index fund that best replicates the said benchmark. This is essential as even after picking a benchmark index to replicate, it is possible that an Index Fund may not be able to replicate it.
For this, you can evaluate some metrics to choose the index fund that might best replicate the benchmark index.
- Tracking Error: This ratio measures how much the fund’s return deviate from the benchmark’s return via standard deviation. The lower the tracking error, the better it is.
- Information Ratio (IR): This ratio shows how consistently the index fund is able to replicate its benchmark returns. A higher IR is better suggesting a better replication. Usually the IR is below 0 for index funds and hence, the more closer the IR of index fund is to 0, the better it is.
- Expense Ratio (TER): Index Funds are low-cost mutual funds. But they still carry an expense ratio. It is important for you to check the TER of an Index Fund as even higher TER means higher tracking error and negative IR.
Taxation of Index Funds in India
Taxation Rules are no different for Index Funds in India than Mutual Funds. If the underlying benchmark index is equity index, same tax rules apply.
STCG – Taxable at 20% if sold within 1 Year. And LTCG – Taxable at 12.5% if sold after 1 Year. â‚ą1.25L exemption is available for LTCG above which it is taxable.
In case, the underlying index is debt index, the gains are taxable at the slab rate of the investor.
Should you invest in Index Funds?
The popularity of Index Mutual Funds in India has been rising rapidly in India and for the right reasons.
As the ability of fund managers to generate active returns becomes difficult over a long period, Index Funds are the go-to-option for long term wealth creation in 2025. And with SEBI pushing for more transparency in the sector, AMCs offering index funds at low-expense ratios, the popularity of Index Funds in India is only going to increase.
For beginners, Index Funds provide a simple, and cost-effective way to participate in Mutual Funds, specially Equities. Through them, Investors can participate in India’s growth story without worrying about stock-picking or sector-picking.
For experienced investors, Index Funds offer a way to diversify their holdings and build a strong foundation for future investing.
In the long run, consistency matters more than just chasing returns by searching for “the next multi-bagger”. And that is what Index Funds deliver – a reliable, low-cost path to wealth creation.
So, whether you are a beginner wondering where to begin your investment journey or an experienced investor looking to improve their core portfolio, Index Funds might just be the right option.
Things to consider when investing in Index funds
1. Risks and Returns
Index funds are passively managed and track a financial index. This means that they are less volatile than other equity funds that are actively managed and hence, less risky.
This is because actively managed funds strive to beat their benchmark but index funds track particular financial indices and try to remain as close to the benchmark as possible.
This means the returns of an index fund usually replicate the performance of the index. This makes these funds reliable and lucrative during a market rally but less so during a slump.
One thing to keep in mind, however, is the tracking error. Most index funds do not replicate their respective indices exactly. There is a small deviation which is called a tracking error. You should always choose a fund with a low tracking error to reduce risk.
2. Investment timeline and goals
Since index funds are considered lower-risk funds, they are suitable for investors looking to make long-term, passive, investments.
These can be investments made for the future education plans of a very young child or retirement plans.
With long-term investment windows, any short-term fluctuations can be balanced out or averaged. But if your goals are less long-term, for example, education plans for an older child, you should consider investing in a more actively managed fund. A good financial advisory service can help you make these decisions.
3. Investment costs and fees
Index funds are passively managed. Since these funds track indices and don’t require active management, they incur lesser fees. An actively managed fund has to pay for analysts and experts to do research and create investment strategies.
A passively managed fund does not have to do that. They have lower operating and management fees, transaction charges, etc. This means that these funds have a lower expense ratio ( the percentage of your total investment that you have to pay to the fund as management fees and other charges).
4. Taxation
Index funds are subject to dividends distribution tax (DDT) and capital gains tax. DDT is deducted at source when the fund pays its dividends to stakeholders.
DDT is generally applied at a rate of 10%. Capital gains tax is the tax levied on the capital gains made when you redeem units of your index fund.
The amount of tax depends on your holding period. If you held the units for less than a year, then you will have to pay short-term capital gains tax (STCG) which is 15%.
Capital gains from a holding period of above one year are considered long-term capital gains (LTCG) and are taxed at 10%. LTCG under Rs.1 Lakh is not taxable.
Who should invest in an Index fund?
Index funds are ideal for investors who want to invest in the equities market but do not want to take a lot of risks. If you are open to a long-term investment with relatively low but fairly predictable results, index funds can be a good option for you.
Keep in mind that index funds will follow the index and not give you any market-beating returns. If you are looking to make investments for your child’s education plans, you may want to stick to index funds for the stability they offer.
However, a much better option would be a diversified investment portfolio with index funds as one of the components.
Education plans are rather high-stakes goals and so it is understandable to want to go safe. However, education, especially if you plan to study abroad, is also expensive.
Actively managed equity funds tend to have generally higher returns. Keeping both in your portfolio can help you get the best of both worlds, general stability as well as good returns.
Investors also Ask
Which is the best index fund in India?Â
There is no right answer to this question. Index Funds replicate their underlying benchmark index. Index Funds that closely replicate their benchmarks consistently are good index funds.
How do I choose an Index Fund?Â
Begin by choosing the benchmark index you want to track. Evaluate the tracking error (prefer low), information ratio (prefer high), and TER (prefer low) to choose the right index fund.
Which Index Fund is good for beginners?Â
You can begin your investment journey by investing in Nifty 50 Index Funds.
Disclaimer: The data in this presentation are meant for general reading purpose only and are not meant to serve as a professional guide/investment advice for the readers. This presentation has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been suggested or offered based upon the information provided herein, due care has been taken to endeavor that the facts are accurate and reasonable as on date. The information placed on the presentation is for informational purposes only and does not constitute as an offer to sell or buy a security. The Company reserves the right to make modifications and alterations to the content available on the presentation. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investment. The EduFund platform & the website is owned, operated and maintained by Helena Edtech Private Limited, a company incorporated under the laws of India. An affiliate of the Company, i.e. Edubillions Tech Private Limited is registered with AMFI as mutual fund distributor bearing the registration number ARN258733. Investment in securities market are subject to market risks, read all the related documents carefully before investing. The valuation of securities may increase or decrease depending on the factors affecting the securities market.
