Index funds have gained tremendous popularity among Indian investors in recent years, offering a simple way to invest in the stock market without the complexity of picking individual stocks. But with dozens of index funds now available in India, how do you choose the right one?
Criteria to keep in mind while choosing the right fund:
- Expense ratio - The expense ratio is the annual fee charged by the fund house and it directly comes into account in the NAV of the mutual fund. Index fund expense ratios typically range from 0.05% to 0.50%. Always compare expense ratios and opt for the lowest cost option when tracking the same index.
- Index - Index funds mimic the different indexes in the market. Nifty 50 tracks the top 50 large-cap companies. It’s the most popular and liquid choice. Sensex tracks 30 large-cap stocks on BSE. Similar to Nifty 50 but with fewer companies. Nifty Next 50 covers the next 50 companies after Nifty 50, giving you mid-cap exposure with relatively lower volatility than broader mid-cap indices. Sectoral/Thematic Indices like Nifty Bank, Nifty IT, or Nifty Pharma. are more concentrated and riskier—suitable only if you have a specific view on a sector. Choose an index that matches your risk appetite and investment goals. For most investors, Nifty 50 or Sensex offers the right balance.
3. Fund size and liquidity - Larger funds with higher Assets Under Management (AUM) generally have better liquidity. A fund with ₹1,000+ crores in AUM is typically more stable, however it is better to keep expense ratio value in check with higher AUM
4. Tracking error - Tracking error measures how well the fund replicates the index. In India, a tracking error of 0.10% to 0.50% is generally acceptable. Higher tracking errors mean you’re not getting true index returns.
Should you choose an ETF or an Index Fund?
Both track indices, but ETFs trade on stock exchanges like stocks, while index funds are traditional mutual funds. Index Funds are easier for SIPs, need no demat account and are bought at end-of-day NAV. ETFs have lower expense ratios, intraday trading possible, require demat account, bid-ask spreads can add costs.
For most retail investors investing through SIPs, regular index funds are more convenient. ETFs suit those wanting to do lump sum investments.
At Upstox, we make this whole investing experience smooth for you by choosing the top funds across categories based on our in-depth research. Just look for the ‘top’ badge on a fund. Do you invest in index funds? What is your filter criteria and which funds have you invested in? Let us know in the comments!