Best Index Funds in India for investment

Are you interested in investing in index funds, but find yourself overwhelmed by the options available in the Indian market? Look no further, as I present to you our comprehensive guide on the best index funds in India. Index funds have gained popularity among investors due to their low costs, diversification benefits, and ability to closely track market indices. In this blog post, I will explore the best index funds in India, providing you with valuable insights and information to make informed investment decisions.

Whether you are a beginner looking to start your investment journey or an experienced investor seeking to diversify your portfolio, this article will help you navigate the world of index funds and identify the best options that align with your financial goals.

Join me as I delve into the word of some of best index funds and discover the top performers in India’s ever-growing market.

Article updated as of 13 April 2024

What is Passive Investment style

Passive investment style refers to an investment approach that aims to replicate the performance of a specific market index or benchmark rather than actively selecting and managing individual investments.

In passive investing, the portfolio is constructed to closely track the returns of the chosen index, such as the S&P 500 or the Nifty 50, by holding a diversified portfolio of securities in the same proportions as the index constituents.

This strategy eliminates the need for extensive research, stock selection, and market timing that are characteristic of active investing. Passive investors believe in the efficiency of markets and the idea that over the long term, the overall market tends to deliver positive returns.

Passive investment vehicles, such as index funds and exchange-traded funds (ETFs), are commonly used in passive investing as they offer broad market exposure, low costs, and a systematic approach to investing. The goal of passive investing is to achieve consistent market returns and capture the overall performance of the market or a specific segment, rather than trying to outperform it.

What are Index Funds?

Index funds are mutual funds or ETFs that aim to replicate the performance of a specific market index. They achieve this by holding a diversified portfolio of securities in the same proportions as the index constituents.

Unlike actively managed funds, index funds do not try to beat the market but rather seek to match its returns. This passive approach results in lower fees and provides broad market exposure without the need for stock picking or market timing.

Index funds are becoming popular choice among investors seeking a cost-effective and efficient way to invest in a specific market or asset class.

What are Advantages Index Funds

Advantages of index funds include:

  1. Broad market exposure.
  2. Diversification.
  3. Lower costs.
  4. Simplicity.

Index funds offer investors an easy and cost-effective way to access the market, diversify their portfolios, and potentially achieve consistent returns while keeping costs low.

What are Risks in Index Funds

While index funds have numerous advantages, it’s important to be aware of the potential risks associated with them:

  1. Market Risk: Index funds are subject to market fluctuations and volatility. If the overall market or the specific index being tracked experiences a downturn, the value of the index fund can decline as well.
  2. Lack of Flexibility: Since index funds aim to replicate the performance of a specific index, they may not adapt to changing market conditions or take advantage of potential investment opportunities. This lack of flexibility can limit the fund’s ability to outperform the market.
  3. Concentration Risk: Index funds are weighted based on the market capitalization of their underlying index constituents. This means that larger companies have a greater influence on the fund’s performance. If a few large companies within the index underperform, it can significantly impact the fund’s returns.
  4. Tracking Error: While index funds strive to replicate the performance of an index, they may not perfectly match its returns due to factors such as expenses, sampling techniques, and timing differences. This tracking error can result in a slight variance between the fund’s performance and the index it tracks.
  5. Sector Concentration: If an index fund focuses on a specific sector or industry, it becomes susceptible to risks associated with that particular sector. Any adverse events or poor performance within the concentrated sector can impact the fund’s returns.

It’s crucial for investors to assess these risks and align their investment strategy accordingly. Diversification and a long-term perspective can help mitigate some of these risks associated with index funds. Best Index funds should address these risks better than other funds.

How are Index Mutual Funds Taxed

Index funds are subject to the same tax rules as other equity funds, as per the new Finance Bill 2023. Here are the key tax provisions:

  1. Short-term profits: If you make profits by selling your investment within a year, they are taxed at a flat rate of 15%, regardless of your applicable income tax slab rate.
  2. Long-term returns: For returns exceeding Rs. 1 lakh made after holding the investment for more than 12 months, a flat tax rate of 10% is applicable.

It’s important to note that these tax rates are subject to any changes in tax regulations from time to time. It’s always advisable to consult with a tax advisor or financial expert for personalised advice regarding taxation on your investments.

What is differences between a Index fund and a Actively managed fund?

Index Fund vs. Actively Managed Fund:

  • Investment Approach: Index funds passively track a specific market index, while actively managed funds aim to outperform the market through active stock selection and timing.
  • Objectives: Index funds seek to replicate the index’s performance, providing broad market exposure. Actively managed funds aim to achieve superior returns through active investment strategies.
  • Fees and Costs: Index funds generally have lower expense ratios due to their passive approach, while actively managed funds tend to have higher costs.
  • Risk and Return: Index funds offer more predictable returns with lower volatility, while actively managed funds carry higher risk and potential for outperformance.

The decision between the two depends on individual preferences, investment goals, and beliefs about passive or active investment strategies.

What are different types of Index Funds in India?

When considering the “best” index fund for long-term investment in India, it is crucial to align the choice with your investment goals, risk tolerance, and specific market preferences. Here are some of the popular indexes:

  1. Nifty 50 Index Fund tracks the Nifty 50 index, which represents the performance of the top 50 Giant-cap stocks on the National Stock Exchange (NSE). Investor who are looking for comparatively less volatility and okay with comparatively lower return, can look at funds following this index. It will invest in top 50 companies listed in Indian Stock Market by capitalisation.
  2. Nifty Next 50 Index Fund focuses on large-cap stocks, this fund mirrors the Nifty Next 50 index, comprising the 50 stocks following the Nifty 50 in terms of market capitalisation. People looking for little more returns over Nifty 50 and are ready to take little more volatility can look for funds following this index. This will invest in top 51 to 100 companies listed in Indian Stock Market by capitalisation.
  3. BSE Sensex Index Fund: By replicating the BSE Sensex, this fund captures the performance of 30 large-cap stocks on the Bombay Stock Exchange (BSE). This is very similar to Nifty 50 but follows Sensex India. This means instead of top 50 companies, it will have only top 30 companies. Naturally this is little more concentrated portfolio compared to Nifty 50. Research have shown that having more than 25 stocks is sufficient to get good diversification. So one can chose either Nifty 50 or Sensex 30 Index for their investment. Theoretically Sensex will be little more volatile and can give slightly more returns compared to Nifty 50.
  4. Nifty Bank Index Fund: Concentrating on the banking sector, this fund mirrors the Nifty Bank index, which includes leading banking companies listed on the NSE. This is for seasoned investors who want to take exposure just to banking sector but want to follow passive approach. Since this is a sectorial index, investors with high risk apetite only should be considering this.
  5. Nifty Midcap 150 Index Fund aims to replicate the Nifty Midcap 150 index, providing exposure to 150 mid-cap stocks listed on the NSE. This index will invest in companies from 101 to 250. So these are relatively mid size companies. Better return in long run but of course higher volatility compared to Nifty 50 or Next 50 or Sensex Index funds. Investor with high risk profile and investment horizon of say 10 plus yers can consider this Index.
  6. Nifty Smallcap index fund is a mutual fund or exchange-traded fund (ETF) that seeks to replicate the performance of the Nifty Smallcap 250 index, which represents the performance of small-cap companies listed on the National Stock Exchange (NSE) in India. This index represents companies ranked from 251 to 500 based on their market capitalisation. So these are small sized companies. Naturally their is good potential to have multi-baggers here but at same time potential to go bankrupt is also higher. So this category can give highest return over long run but also has very high risk associated.
  7. Nifty 500 index fund is a mutual fund or exchange-traded fund (ETF) that aims to replicate the performance of the Nifty 500 index, which represents the top 500 companies listed on the National Stock Exchange (NSE) in India. This is a very broad base index investing in all top 500 companies based on market capitalisation. Generally most diversified index. Investor with lower risk apetite can consider this as alternative to Nifty 50 or Sensex Index as it has some potential for better returns due to exposure to mid and small caps.
  8. Equal Weight Index – Most of the Indices have allocation to companies based on their individual market capitalisation. So HDFC and Reliance will have higher allocation compared to say ICICI and Infosys etc. However some fund have version with equal weight. This index will have equal allocation to all companies in the index. So Nifty 50 equal Weight index will have 2% allocation to each of 50 companies in Nifty 50 Index. This is a variation of index.
  9. Other variants – What I covered here are common and popular indices. However there are 100s of indices (not all having funds though). If you are interested, do visit niftyindices and click on Indices Menu to explore more.

Perform thorough research on each fund’s investment objective, past performance, expense ratio, and track record. It is advisable to seek guidance from a financial advisor who can offer personalised advice based on your specific investment requirements and risk appetite.

Which Index investor should chose for investing?

Since Index Mutual Fund track underlying Index, It is important first to decide which index is appropriate for you based on your investment objective, investment horizon, risk profile & track record of Index.

When it comes to selecting an index for investment purposes, one should the following steps:

  1. Define Investment Objectives: Determine your investment goals, risk tolerance, and time horizon. Clarify whether you are seeking broad market exposure or targeting a specific sector or asset class.
  2. Research Available Indices: Identify the indices that align with your investment objectives. Consider widely recognized and reputable indices such as Nifty 50, BSE Sensex, S&P 500, or Nifty Bankex, etc. Research the constituents, methodology, and historical performance of each index.
  3. Evaluate Index Composition: Analyze the composition of each index, including the number of securities included, market capitalization criteria, sector allocations, and geographical coverage. Ensure the index represents the market segment or theme you want to invest in.
  4. Assess Index Methodology: Understand the methodology used to construct and maintain the index. Look for transparency, robustness, and adherence to recognized standards. Consider factors such as market capitalization weighting, equal weighting, or factor-based weighting.
  5. Review Performance and Volatility: Examine the historical performance of the index, including its returns, volatility, and risk characteristics. Consider both short-term and long-term performance to evaluate consistency and resilience across different market conditions.
  6. Consider Index Provider: Assess the credibility and reputation of the index provider. Look for established providers known for their accurate and reliable index construction methodologies. Consider factors such as data integrity, independence, and regulatory compliance.
  7. Compare Index Costs: Evaluate the costs associated with tracking or investing in the index. Consider factors such as licensing fees, transaction costs, and index fund expense ratios. Lower costs can enhance your investment returns over the long term.
  8. Monitor Index Relevance: Regularly review the index’s relevance and suitability for your investment strategy. Keep track of any changes to the index composition, methodology, or market trends that may affect its performance.

Remember that index selection is crucial as it determines the exposure and risk profile of your investments. It’s recommended to conduct thorough research, consult with financial advisors or investment professionals, and stay updated with market developments to make informed decisions.

Also note there is no need to invest in just one Index. A balanced risk profile investor may invest 50% corpus in Nifty 50, 30 % in Nifty Midcap 150 and 20% in Nifty small cap 250. One can discuss his or her case with his advisor and come up with appropriate allocation to different indices.

Also it is good practice to diversify across Fund Houses. So if you invest in Nifty 50 Index Fund from DSP Mutual Fund then Midcap and smallcap one can invest from say Motilal and HDFC fund houses.

Which is the best Index fund to invest in for the long term in India?

There are different factors that one should consider for selecting Index Fund compared to Active Funds. In case of active funds, Fund Manager plays critical role in decision making.

For Index Fund, one should consider following aspects:

  • Fund AUM – Larger the fund, better the index fund. This is because as fund size grows, making changes in line with underlying companies is easier.
  • Tracking Error – This is difference of returns of fund compared to underlying Index. Since we are using passive investment style, we want fund performance as low as possible. If Index returns say 25% and there are two Indiex Funds with say 25.3% return and 24.95% return. Here you may feel higher return fund is better. That is not case with Index fund. Here we want our fund to have return as close to Index as possible. So in this example, fund with 24.95% return is having lower tracking error and should be the choice.
  • AMC – Though not a critical factor, some AMCs like Nippon Mutual Fund are focusing on more and more Index funds. So if all other factors remain same, it would be good idea to invest in fund of such AMCs as managing multiple index funds can give them some edge from cost and process perspective.

Let us look at some of the good Index Funds in India. This should help you select right one for you based on Index that is suitable for your goal.

IndexBest Index Fund3 year returns
Nifty 50 IndexDSP Nifty 50 Equal Weight Index Fund22.5%
HDFC Index Fund – Nifty 50 plan17.3%
Nifty Next 50DSP Nifty Next 50 Index Fund23.8%
BSE SensexHDFC Index Fund – S&P BSE Sensex Plan16.8%
Nifty Bank IndexNippon India ETF Nifty PSU Bank BeES54.3%
Nifty Midcap 150Motilal Nifty Midcap 150 Index Fund28.9%
Nifty SmallcapMotilal Oswal Nifty Small Cap 250 Index Fund37.5%
Nifty 500 indexMotilal Oswal Nifty 500 Index Fund20.6%
*returns as of 13 April 2024

Are Index Funds good for Future?

Investments should not be done looking in rear mirror. So more than past record, we should assess how the future looks for Index funds.

The EPFO started investing in equities through ETFs in 2015-16 with a 5% exposure. The equity investment limit was raised to 10% in 2016-17 and 15% in 2017-18. Its cumulative investment in ETFs till March 31, 2022, stood at ₹1,01,712.44 crore, or 9.24% of total investment of ₹11,00,953.66 crore. This is expected to go on and will help Index perform better.

Because of this regulatory restriction, National Pension System (NPS) Funds effectively invested in only around 100 large-cap stocks. As per SEBI’s rules, the top 100 companies in terms of market cap are classified as large-cap stocks.

Both EPFO and NPS is going to bring in significant money to stocks mostly in large cap based index. So unless there is some major change in their approach, large cap indices are likely to have performance edge over others.

Best Index Funds – Conclusion

In conclusion, investing in index funds can be a prudent choice for long-term investors seeking broad market exposure with lower costs. The Indian market offers a range of index funds that track various indices, catering to different investment objectives and risk profiles.

Before selecting the best index fund for your investment needs, consider factors such as the fund’s objective, performance history, expense ratio, tracking error, and fund manager’s expertise. Additionally, align the fund’s index selection with your investment goals and risk tolerance.

Remember that while index funds provide diversification and potentially lower fees compared to actively managed funds, they also come with market risk and may not outperform the market. It is crucial to maintain a long-term perspective and regularly review your investment strategy to ensure it remains aligned with your financial goals.

Lastly, it is advisable to seek guidance from a financial advisor or investment professional who can provide personalised advice based on your specific circumstances and help you make well-informed decisions.

By considering these factors and conducting thorough research, you can confidently choose the best index fund that suits your investment objectives and embark on a path to long-term wealth creation. Happy investing!

So do let me know in comments as which one in the list of Best Index funds you like and are investing in.

Also check out Best Mutual Funds in India in other categories.

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